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Archived - Dept Management Report 2005-2006 : 1
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Foreword by the Minister of Finance
I am pleased to table in Parliament the Government of Canada’s Debt Management Report for fiscal year 2005–06. The report provides a full and transparent account of how Canada’s debt is managed.
Canada has made great inroads in reducing its federal debt, wiping over $80 billion from its books and reducing the debt burden to its lowest level in a quarter of a century. This is a significant investment in the financial security of our children and grandchildren.
At the same time, the Government has set aside the resources needed to pursue such national priorities as cracking down on crime, offering more choice in child care, reducing taxes and taking the necessary steps to restore fiscal balance to our country.
This year and going forward, the Government plans to achieve annual debt reduction of $3 billion, while reducing growth in program spending to a more sustainable rate. Thanks to this approach, we will be able to reach our debt-to-GDP (gross domestic product) goal of 25 per cent by 2013–14. This reduced debt burden will offer Canada new opportunities to pursue such goals as an improved quality of life, a cleaner environment and a stronger economic union.
The Government’s improved financial status has provided challenges for debt management, most notably maintaining a well-functioning government securities market, while adjusting the structure of the debt to reduce its cost for taxpayers. This year’s Debt Management Report highlights recent debt management initiatives, including:
- Continuing to lower debt costs by reducing the fixed-rate component of the debt toward 60 per cent from two-thirds by 2007–08.
- Maintaining the liquidity of new Government of Canada bond issues through continued buybacks of outstanding debt and making some new issues fungible with existing bond issues.
- Adjusting the operational framework for auctions to promote dealer and investor participation.
- Assessing the merits of consolidating the borrowing activity of major government-backed entities with those of the federal government.
By remaining true to its commitments and the core values of Canadians, our government will ensure the country’s economy remains secure and prosperous today and for future generations.
The Honourable James M. Flaherty, P.C., M.P.
Minister of Finance
Ottawa, November 2006
Purpose of This Publication
This edition of the Debt Management Report provides a detailed account of the Government of Canada’s borrowing and cash operations for fiscal year April 1, 2005 to March 31, 2006.
It provides a comprehensive report on the environment in which the debt is managed, the composition and changes in the debt during the year, and the implementation of planned borrowing operations and initiatives set out in the 2005–06 Debt Management Strategy, published in March 2005. Reference tables containing statistics on the operation of debt programs are provided at the end of the report.
The information contained in this report is designed for a range of interested parties and to ensure transparency and accountability in Government of Canada borrowing and cash management activities. Information on the management of the foreign reserves is provided in a separate report, the Report on the Management of Canada’s Official International Reserves. The Debt Management Strategy, the Debt Management Report and the Report on the Management of Canada’s Official International Reserves 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 for operations. As of March 31, 2006, the market debt was $427.3 billion, composed of marketable bonds, treasury bills, retail debt, foreign currency debt and Canada Pension Plan (CPP) bonds. The Government held $21.1 billion of domestic cash balances.
|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)
| Treasury bills and CMBs
(zero-coupon securities with 1-day to 12-month maturities)
| Retail debt
(Canada Savings Bonds and Canada Premium Bonds)
|Payable in foreign currency|
| Marketable bonds and foreign currency notes
(fixed-rate bonds, Canada notes and Euro
| Canada bills
(zero-coupon securities with 1- to 9-month maturities)
|Total market debt||427.3|
|Liquid Financial Assets|
|Short-term deposits with financial institutions||18.0|
|Source: Public Accounts of Canada.|
This document is structured as follows:
- The introduction provides highlights of the debt program for 2005–06, as well as information related to governance and the debt strategy framework.
- Part I describes the fiscal environment in which the debt is managed and the composition of market debt.
- Part II reports on the implementation of borrowing program initiatives against the 2005–06 debt strategy by major theme: cost and risk of the debt structure; liquidity in the Government of Canada securities market; review of borrowing framework policies; and participation at government securities auctions.
- Part III provides measures of outcomes during 2005–06 of domestic program operations and auction participation; indicators of secondary market activity; and indicators of foreign reserves funding.
- Annex 1 explains the composition of the federal debt, Annex 2 lists treasury evaluations performed since 1992, Annex 3 contains a glossary of debt management terms and Annex 4 contains contact information.
- Reference tables provide historical information on debt-related activities.
Continued Decline in Federal Indebtedness
In 2005–06, the level of federal indebtedness continued to decline. On a full accrual basis, the federal debt was reduced by $13.2 billion to $481.5 billion, down $81.4 billion from its peak in 1996–97. With a budgetary surplus of $13.2 billion and a net requirement from non-budgetary transactions of $6.4 billion, there was a financial source of $6.8 billion in 2005–06. With this financial source, $6.3 billion of unmatured debt was retired and cash balances were increased by $0.5 billion.
Debt-servicing charges were down $0.3 billion to $33.8 billion from fiscal year 2004–05, reflecting the impact of a decline of $6.2 billion in the stock of interest-bearing debt. Gross public debt charges as a percentage of interest-bearing debt was unchanged from last year’s rate of 5.6 per cent. Debt-servicing charges were down $15.6 billion from fiscal year 1996–97 (for more information, see the 2005–06 Annual Financial Report of the Government of Canada at www.fin.gc.ca/purl/afr-eng.asp).
Adjusting the Structure of the Market Debt
Adjustments in the level of treasury bill and net bond issuance continued the process begun in 2003–04 of reducing the fixed-rate share of the debt from two-thirds to a target of 60 per cent by 2007–08. The fixed-rate share fell from 63.1 per cent to 62.5 per cent over the course of the year. The stock of treasury bills and cash management bills increased by $4.4 billion to $131.6 billion, while the stock of nominal bonds declined by $6.9 billion to $237.3 billion in 2005–06.
Maintaining a Liquid Government Securities Market
The main challenge in managing the federal debt in recent years has been to support the maintenance of a liquid, well-functioning government securities market as a source of stable low-cost funding in the face of declining borrowing requirements. To this end, debt operations during the 2005–06 fiscal year continued to focus on maintaining the liquidity of new issues through continued buybacks of outstanding debt and adjusting the new 2-year issuance to take advantage of fungibility (i.e. the ability to combine different bonds that share the same maturity date) with existing bond issues.
In November 2005, officials from the Department of Finance and the Bank of Canada consulted with interested parties on issues relating to the design and operation of the Government of Canada’s debt programs for fiscal year 2006–07 and beyond. The consultations supported the initiative to maintain liquidity through fungibility for 2006–07 by forgoing one 5-year auction that is fungible with a previous 10-year benchmark, as announced in the 2006–07 Debt Management Strategy (for more information, see Debt Strategy Consultations 2006/07 at www.bankofcanada.ca/en/notices_fmd/2005/not281005.html and the 2006–07 Debt Management Strategy at www.fin.gc.ca/toc/2006/dms06-eng.asp).
Operational changes made in 2005–06 to encourage participation and promote liquid and efficient markets included: advancing the timing of bond auctions from 12:30 p.m. to 12:00 p.m.; advancing the timing of cash bond buybacks from 1:00 p.m. to 12:20 p.m.; and reducing the turnaround time in which auction and buyback results are made public.
An evaluation of the debt distribution framework for Government of Canada securities was completed during the year. Changes to the framework for auctions, which included adjustments in auction access for dealers and customers and changes to minimum bidding obligations of dealers, were announced on the Bank of Canada’s website in August 2005 (for more information, see www.bank-banque-canada.ca/en/notices_fmd/2005/not080805.html).
Review of the Crown Borrowing Framework
An external evaluation of the borrowing framework used by major federal government-backed entities was completed by an external evaluator in June 2005. It was observed that consolidation of Crown borrowing activity with the federal borrowing program could support the liquidity of the Government of Canada securities market and result in a reduction in aggregated borrowing costs. It was also noted that a range of issues required further analysis to assess the merits of such an initiative. Follow-up analysis was undertaken in consultation with the Crown corporations. This process was ongoing at the time this report was prepared.
Debt Strategy Framework
Part IV of the Financial Administration Act empowers the Minister of Finance to issue securities and to 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. This report is intended to fulfill this obligation and to support public transparency and accountability.
Responsibility for strategic planning and the operational management of the market debt and liquid assets, including the foreign exchange reserves, all of which is termed "funds management," 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, investing funds and conducting other market operations (see www.fin.gc.ca/treas/Goveev/TMGF_1-eng.asp).
The oversight of activity is carried out through a 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. 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 certain financial assets and foreign-currency-denominated derivatives, including market, credit, operational, liquidity and legal risks.
In order to inform future decision making and to support transparency and accountability, different aspects of the Government of Canada’s treasury activities are reviewed periodically under the Department of Finance’s treasury evaluation program. The program’s purpose is to assess the frameworks and processes used in the management of wholesale and retail market debt, cash and reserves as well as the treasury activities of other entities under the authority of the Minister of Finance (see the section "Program Reviews and Evaluations" and Annex 2).
Objectives and Principles
The federal debt strategy covers the management of federal market debt and operational activities related to it, including the management of cash balances and the funding of the foreign exchange reserves.
Debt and cash management are conducted in view of objectives and principles. All funds management activities are conducted in view of overarching principles.
The fundamental objective of debt and cash management is to raise stable and low-cost funding to meet the operational needs of the Government of Canada.
An associated objective is to maintain a well-functioning market in Government of Canada securities, which helps to keep debt costs low and is of benefit to domestic market participants.
Transparency, Regularity and Liquidity
The design and implementation of the debt program should emphasize transparency, regularity and liquidity to support a well-functioning government securities market. The Government should consult regularly with market participants to ensure the integrity and attractiveness of the market for dealers and investors.
Prudence should be pursued by managing the structure of the debt, by raising funds for operational needs using a variety of instruments denominated in the currency of need, and by managing exposure to credit risk through diversification.
Overarching Funds Management Principles
Part I: 2005–2006 Debt Management Context
Since the annual debt-servicing cost is the largest single budgetary expense, effective management of the federal debt is important to all Canadians. This section provides an overview of the context within which 2005–06 debt management decisions were taken.
The Budgetary Context
Budgetary Outcome and Public Debt Costs
A budgetary surplus of $13.2 billion was recorded in 2005–06, the ninth consecutive surplus. The federal debt has been reduced by $81.4 billion since its peak in 1996–97. The federal debt-to-GDP (gross domestic product) ratio has fallen 33.3 percentage points from its peak of 68.4 per cent in 1995–96 to 35.1 per cent in 2005–06 (see Chart 1), its lowest level since 1981–82. As announced in the 2006 budget, a debt-to-GDP ratio of 25 per cent is to be achieved by 2013–14.
In 2005–06, 15.2 cents of every dollar of revenue was spent to pay interest on the public debt, down from a peak of almost 38 cents in 1990–91. Public debt charges as a percentage of GDP declined to 2.5 per cent in 2005–06 from 2.6 per cent in 2004–05 (see Chart 1). In 2005–06, gross public debt charges as a percentage of interest-bearing debt was unchanged from last year’s rate of 5.6 per cent (for detailed information, see the 2005–06 Annual Financial Report of the Government of Canada at www.fin.gc.ca/purl/afr-eng.asp).
The key budgetary reference point for 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 reflects current- and prior-year budgetary items, as well as the cash requirements for non-budgetary transactions. As such, the financial source/requirement drives the changes in the market debt and in the level of financial assets.
In 2005–06, the budgetary surplus of $13.2 billion and a net requirement of funds from non-budgetary transactions of $6.4 billion produced a financial source of $6.8 billion (see Chart 2). This compares to a financial source of $6.6 billion in 2004–05, $7.6 billion in 2003–04 and $9.4 billion in 2002–03. The financial source contributed to a $6.3-billion reduction in unmatured debt and a $0.5-billion increase in cash balances at year-end.
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. For accounting purposes, gross debt is decomposed into: market debt, which is issued and outstanding in financial markets; value adjustments to market debt (for the foreign exchange value of swap liabilities and the net of unamortized premiums and discounts of new issues and buybacks); capital leases; and other liabilities. Other liabilities comprise liabilities held outside capital markets and include obligations to public sector pension plans as well as accounts payable and accrued liabilities and allowances.
The following diagram illustrates the relationships between the components of the federal debt, based on the 2005–06 fiscal year. See Annex 1 for a more detailed description of the composition of the federal debt.
Of note, the presentation of unmatured debt in the Public Accounts of Canada has been rearranged for 2005–06. Unamortized premiums, discounts, and commissions have been reclassified from the "interest and matured debt" line of the financial statements to "unmatured debt" in the Statement of Financial Position. The cross-currency swap revaluation account has also been shifted from "accounts payable and accrued liabilities" to "unmatured debt" in the Statement of Financial Position. These changes were made so that all amounts pertaining to the current value of unmatured debt are grouped under the same section in the financial statements.
There are two types of market debt: domestic debt, which is denominated in Canadian dollars, and foreign currency debt (see Chart 3). Funding in Canadian dollars is done through wholesale and retail channels. Wholesale funding is conducted through issuance of marketable securities, which include nominal bonds, Real Return Bonds, treasury bills and cash management bills. These securities are sold via auctions to Government of Canada securities distributors and end-investors (details on the framework for government securities distributors and primary dealers can be found at www.bankofcanada.ca/en/auct.html). Retail funding is raised through sales of Canada Savings Bonds and Canada Premium Bonds to individuals who are Canadian residents (see www.csb.gc.ca for more information about the retail debt program).
See www.fin.gc.ca/invest/instru-eng.asp for a detailed description of the Government of Canada’s market debt instruments.
Funds raised in Canadian dollars are used primarily to meet operational requirements. A portion of Canadian-dollar wholesale debt is swapped to foreign currencies to fund the Government’s foreign exchange reserves. Chart 4 shows the composition of market liabilities taking these swaps into account.
Table 1 shows the change in the composition of federal market debt as at March 31, 2006, by domestic and foreign debt programs. Total domestic debt fell by $2.3 billion while foreign currency debt declined by $2.2 billion. Further details on the changes in programs and indicators of debt management operations and activities can be found in Part III.
Change in the Composition of Federal Market Debt
|April 1, 20051 Outstanding||March 31, 2006 Outstanding||Change|
|Foreign currency debt2||16.3||14.1||-2.2|
|Total market debt||431.8||427.3||-4.5|
1 The comparative figures have been restated to reflect the current year’s presentation.
2 Liabilities are stated at par value using March 31, 2006, closing exchange rates.
Source: Public Accounts of Canada.
Part II: Report on the 2005–2006 Debt Strategy
The 2005–06 Debt Management Strategy, published in March 2005, set out an action plan for the management of the debt and cash balances (for more information, see www.fin.gc.ca/toc/2005/dms05-eng.asp). A summary of the plan and actions taken is provided at the end of this part of the report. This section reports in more detail on actions taken, organized around two key debt strategy objectives: raising stable, low-cost funding and maintaining a well-functioning government securities market.
Raising Stable, Low-Cost Funding
Achieving the objective of raising stable, low-cost financing involves managing the Government’s exposure to changes in interest rates and their impact on borrowing costs (interest rate risk). This section highlights the actions taken to manage interest rate risk.
The Government’s interest-bearing debt is made up of a mix of short- and long term-debt. There is generally a trade-off between cost and risk in the selection of which instruments to issue. Borrowing costs of longer-term instruments tend to be higher but are fixed for long periods, therefore reducing the risk to refinance at higher interest rates. On the other hand, borrowing costs of shorter-term instruments tend to be lower on average but are fixed for shorter periods, therefore increasing the risk to refinance at higher interest rates. Under the debt strategy, the balance between fixed- and floating-rate debt in the market debt structure is managed over time to keep debt-servicing costs stable and low.
The main operational target used to manage the debt structure is the fixed-rate share, which measures the proportion of all government interest-bearing debt having fixed rates—debt that does not mature or need to be repriced within one year—relative to the total amount of interest-bearing debt. The February 2003 budget announced the intention of reducing the fixed-rate share target from two-thirds to 60 per cent in 2007–08 (see Chart 5).
The decision to lower the fixed-rate share took account of 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 the vast majority of potential interest rate scenarios without compromising debt-cost stability.
The fixed-rate share declined from 63.1 per cent to 62.5 per cent over the 2005–06 fiscal year. The change in debt structure will continue to be implemented gradually, in an orderly and transparent manner, over the next two years.
As a consequence of the adjustment in the fixed-rate share, the stock of outstanding treasury bills and cash management bills, which are considered floating-rate debt, increased from $127.2 billion to $131.6 billion in 2005–06, while the stock of outstanding fixed-rate nominal bonds declined from $244.3 billion to $237.3 billion.
A related strategy to reduce the risk of higher borrowing costs is the establishment of a well-distributed maturity profile which limits the need to refinance a large portion of the debt in any given year when borrowing conditions may be unfavourable. In 2005–06, debt issuance plans continued to emphasize the distribution of borrowing across three benchmark treasury bill maturities (3, 6 and 12 months) and five benchmark bond maturities (2-, 5-, 10- and 30-year nominal bonds plus a 30-year Real Return Bond). Issuance in a broad range of benchmark maturities ensures a controlled exposure to changes in interest rates over time and provides liquidity across investor segments, instruments and maturities, which contributes to managing both cost and risk.
Maintaining a Well-Functioning Market
A well-functioning wholesale market in Government of Canada securities is important and of benefit to the Government as a borrower and to a wide range of market participants. For the Government as a debt issuer, a well-functioning market attracts investors and contributes to keeping funding costs low and stable over time. 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 2005–06, the following actions were taken to promote liquidity in Government of Canada securities:
- Regular and transparent issuance: The practice of pre-announcing quarterly bond auction schedules was continued. As in recent years, regular auctions included quarterly 2-, 5-, 10-year and 30-year Real Return bond auctions, and semi-annual 30-year nominal bond auctions. Regular and pre-announced issuance provided certainty for dealers and investors in terms of planning their investment activities and supported participation and competitive bidding for auctions of securities.
- Benchmark target sizes: The 2-, 5-, 10- and 30-year new building benchmark target sizes were unchanged from the previous year (2-year bonds: $7 billion to $10 billion; 5-year bonds: $9 billion to $12 billion; 10-year bonds: $10 billion to $14 billion; and 30-year bonds: $12 billion to $15 billion). All benchmarks built in 2005–06 were within their target range. In the case of building benchmarks that were fungible with large existing bonds, the benchmark size was deemed attained when the total amount of outstanding bonds for a particular maturity date exceeded the minimum benchmark size for that maturity sector.
- Regular buybacks: The regular bond buyback program differs from the cash management bond buyback program in that the former serves to maintain gross bond issuance, while the latter helps to manage cash requirements effectively by reducing large bond maturities.
Against the backdrop of debt paydown in recent years, use of the regular bond buyback program on both a switch and cash basis to repurchase less liquid off-the-run bonds with more than one year to maturity (i.e. securities that are no longer the current or the previous building benchmark) has helped maintain gross bond issuance and benchmark bond sizes at higher levels than would have been possible without the buyback program, considering the Government’s funding requirements. Buybacks on a cash basis are "reverse auctions," where off-the-run bonds offered to the Government are exchanged for cash. Buybacks on a switch basis, are also "reverse auctions" but involve the exchange of off-the-run bonds from the market for the current building benchmark.
The 2005–06 Debt Management Strategy outlined a buyback target of between $9 billion and $10 billion, roughly $1.5 billion less than in 2004–05. During the fiscal year, $32.4 billion in gross new benchmark bonds were issued and $8.6 billion in off-the-run bonds were repurchased. In 2005–06, $3.3 billion in bonds were repurchased through the switch program (a decrease of $1.4 billion from 2004–05), and $5.3 billion through the cash buyback program (a decrease of $1.5 billion from 2004–05).
The cash management bond buyback (CMBB) program, through which a portion of the outstanding benchmark bonds maturing in up to 18 months are repurchased prior to their maturity, helps manage cash requirements by reducing the high levels of cash balances needed for key coupon and maturity payment dates. Overall, the CMBB programs in 2004–05 and 2005–06 lowered large bond maturities occurring in 2005–06 by 30 per cent, reducing the market impact of holding high levels of cash balances for coupon and maturity payment dates.
As a result of actions taken to promote liquidity in Government of Canada securities, there are now fewer small, illiquid high coupon bonds and more large and liquid old benchmarks than there were in 2000. Since 2000 the number of bonds has been reduced from 71 to 51 while the average size per maturity date has increased from $5 billion to $6 billion.
Impact of Debt Management Activities on Profile of Outstanding Bonds
|Nominal Bonds||Real Return Bonds||Total|
|Total bonds outstanding
|Average size per maturity date ($ billions)||5.0||6.1||4.0||5.1||5.0||6.0|
|Number of bonds outstanding||68||47||3||4||71||51|
|Number of maturity dates||56||39||3||4||59||43|
|Weighted average coupon rate (%)||7.52||5.54||4.22||3.92||–||–|
|Sources: Bank of Canada and Public Accounts of Canada.|
Program Reviews and Evaluations
Regular assessment of treasury management frameworks and programs is undertaken as part of good governance and management of the debt program.
Review of the Debt Distribution Framework
In the fall of 2004, an evaluation of the debt distribution framework for Government of Canada securities was launched. The purpose of the review was to assess the framework’s effectiveness in raising stable, low-cost funding while supporting a well-functioning market for Government of Canada securities, and determine whether changes to the framework were warranted.
The review was considered timely and appropriate given the evolution of the Government of Canada securities market since the previous review of the framework in 1998. The recent environment is characterized by 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.
After internal analysis and consultations with interested parties, the review concluded that the framework is generally working well, with auctions consistently covered and well bid. Modest changes to the framework were announced on the Bank of Canada’s website in August 2005, and came into effect in December 2005. These changes fell into two broad areas: adjustments in auction access for dealers and customers, and changes to minimum bidding obligations of dealers (for more information, see www.bank-banque-canada.ca/en/notices_fmd/2005/not080805.html).
Review of the Design of the Bond Program
In November 2005, officials from the Department of Finance and the Bank of Canada consulted with interested parties on issues relating to the design and operation of the Government of Canada’s debt programs for fiscal year 2006–07 and beyond.
The focus of the market consultations was to assess potential structural changes to the bond program in light of declining fixed-rate borrowing needs. The consultations revealed that market participants recognize the challenges in maintaining well-functioning markets for Government of Canada securities in the context of lower borrowing needs and the movement towards a lower fixed-rate share of the Government’s debt.
The consultations identified a broad spectrum of options, ranging from modest to more fundamental changes, for adjustment of the bond program in the short and medium terms. Measures announced in the 2006–07 debt strategy include forgoing one 2-year and one 5-year fungible auction, changing the maturity of the 5-year benchmark bond from September to June and continuing the bond buyback program. A measure which was also raised but not adopted was the potential use of an interest rate swap program as a tool to continue to reduce the fixed-rate share of the debt while minimizing the impact on gross bond issuance and benchmark sizes (for additional details, see www.bank-banque-canada.ca/en/notices_fmd/2006/ not060406_strategy.html).
Review of the Borrowing Framework of Major Federal Government-Backed Entities
In 2004, KPMG LLP was engaged under the treasury evaluation program to determine whether the current regime governing capital market borrowings by major federal government-backed entities was functioning effectively. The review also considered alternative borrowing frameworks to determine if they could reduce cost and risk and enhance the liquidity of Canadian capital markets, taking into account the varying needs of the borrowers.
In its report, published in September 2005 (see www.fin.gc.ca/toc/2005/mfgbe-eng.asp), KPMG LLP observed that the current governance system between the Government of Canada and all of the organizations is functioning well. The report identified potential improvements to the terms of borrowing authorities provided by the Minister, the reporting of performance, as well as the sharing of information on funding activity. With respect to alternative borrowing frameworks, KPMG LLP observed that an approach worth considering is the consolidation of Crown borrowing activity with the Government’s own borrowing program.
The merits of consolidating some or all of the borrowing by major government-backed entities into government debt programs was being further assessed at the time this report was prepared.
Participation in Operations
Active participation at auction and buyback operations by a diverse group of market participants also helps achieve the key objective of stable, low-cost funding. Initiatives to enhance transparency and the bidding process have been undertaken to broaden participation over the past few years.
An important initiative undertaken in 2005–06 was to advance the timing of bond auctions from 12:30 p.m. to 12:00 p.m. and to advance the timing of cash bond buybacks from 1:00 p.m. to 12:20 p.m. Moving the timing of these operations earlier in the day when demand for Government of Canada securities may be stronger as well as decreasing the time interval between the two operations by 10 minutes has reduced market risk for participants. In addition, the time in which auction and buyback results are made public (turnaround time) continued to improve (see Chart 6).
Lower turnaround times and advancing the time of the auction and of the cash buyback enhance the efficiency of the auction and buyback process and encourage participation by reducing the market risk for participants. In consultations on the development of the debt strategy, market participants have indicated their satisfaction with these changes.
There has been a significant reduction in turnaround times in recent years, from 45 minutes at the end of 1998, to an average of close to 2 minutes for treasury bill and bond auctions and an average of less than 4 minutes for buyback operations in 2005–06. Turnaround times have been on a "best efforts basis" since April 6, 2004 (see Charts 6 and 7).
As announced in the 2006–07 Debt Management Strategy, the Bank of Canada is currently targeting an average turnaround time of less than 3 minutes for auctions and less than 5 minutes for buybacks. Similarly, maximum turnaround times have been reduced from 10 minutes to 5 minutes for auctions and from 15 minutes to 10 minutes for buyback operations.
Debt Strategy Plan and Summary of Actions Taken
The following summary reports on the planned initiatives, their purpose and actions taken through 2005–06, as outlined in the Debt Management Strategy published in March 2005 (www.fin.gc.ca/toc/2005/dms05-eng.asp).
Gradually reduce the fixed-rate share of debt from two-thirds to 60 per cent by 2007–08.
|Plan||Intended Result||Actions Taken|
|Continue to reduce the fixed-rate share of 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 63.1 per cent to 62.5 per cent over the 2005–06 fiscal year.|
|Increase the size of the treasury bill program from about $130 billion in 2004–05 to approximately $140 billion in 2005–06.||The stock of outstanding treasury bills and cash management bills increased by $4.4 billion from $127.2 billion to $131.6 billion due to a larger than expected financial source.|
|Issue about $33 billion of bonds in 2005–06, about $3 billion less than in 2004–05. Due to large bond maturities and continued bond buyback operations, the bond stock is expected to decrease by some $8 billion, to $235 billion.||Facilitate market adjustment to changes in the bond and treasury bill programs.||$32.4 billion of nominal bonds were issued. The stock of outstanding bonds declined by $6.9 billion to $237.3 billion.|
|Reduce the size of the regular bond buyback program, with a planned level of between $9 billion and $10 billion, roughly $1.5 billion less than in 2004–05.||Preserve liquidity in outstanding issues.||$8.6 billion of bonds were repurchased through the regular bond buyback program on a cash and switch basis.|
|Maintain a stable maturity profile by continuing to issue in all sectors of the curve and by using the cash management bond buyback (CMBB) program to reduce large maturities.||Limit the need to refinance a large portion of debt in any given year.||
Average term to maturity was maintained above 6.5 years.
$8.7 billion of bonds were repurchased through the CMBB program. The 2004–05 and 2005–06 CMBB operations reduced large maturities in 2005–06 by 30 per cent on average.
|Debt Strategy Plan and Summary of Actions Taken (cont’d)
Domestic Debt Programs
Objective: Maintain diversified sources of funding and a well-functioning market.
|Plan||Intended Result||Actions Taken|
|Continue regular issues of marketable bonds in four maturity sectors, treasury bills in three maturity sectors, and a 30-year Real Return Bond.||Keep costs low and mitigate funding risk by diversifying borrowing across investor segments, instruments and maturities.||Issuance schedule and maturities of past years were maintained in treasury bills, nominal bonds and Real Return Bonds.|
|Continue to borrow on a pre-announced basis and provide timely notices of government policy decisions.||Maintain transparency and efficiency.||The issuance schedule was maintained and announced prior to the start of each quarter.|
|Maintain current new maturity benchmark target sizes for 2-, 5-, 10- and 30-year bonds.||Maintain a liquid market for on-the-run issues and building benchmark issues.||Benchmark bond target ranges were achieved.|
|Forgo the 2-year auction in the fourth quarter of 2005–06, where it was fungible with a large existing bond.||Facilitate a reduction in gross bond issuance to lower the fixed-rate share of the debt while maintaining liquidity in that sector of the yield curve.||Liquidity in the 2-year sector was achieved.|
|Consult with market participants in 2005–06 on potential changes to the structure of the bond program.||Adjust the structure of the bond program to achieve a 60-per-cent fixed-rate share by 2007–08 while maintaining a well-functioning government securities market.||Consultations took place in late 2005. A summary of comments received from interested parties was posted on the Bank of Canada’s website on April 7, 2006.|
|Advance the timing of bond auctions from 12:30 p.m. to 12:00 p.m. and advance the timing of cash buybacks from 1:00 p.m. to 12:20 p.m., 10 minutes closer to the bond auction than previously.||Encourage participation by moving the timing of these operations earlier in the day when demand for Government of Canada securities may be stronger and decreasing the time interval between the two operations to reduce market risk for participants.||The new timing of auction and buyback operations was successfully implemented.|
|Continue to work to lower turnaround times for the release of results of auctions and buybacks.||Enhance the bidding process and participation by reducing market risk for participants.||Turnaround times on a best efforts basis have averaged close to 2 minutes for auctions and less than 4 minutes for buybacks.|
|Update the retail debt strategy.||Ensure the evolving needs of the Government of Canada and Canadians are met.||A program evaluation is ongoing with efforts focused on cost reduction and improving efficiency.|
Objective: Improve the cost-effectiveness of funding foreign reserves assets.
|Plan||Intended Result||Actions Taken|
|Note: The 2005–06 debt strategy also included the objectives listed below for the management of the foreign reserves portfolio, 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 (see the Report on the Management of Canada’s Official International Reserves at www.fin.gc.ca/toc/2006/oir06_-eng.asp for details on actions in the area of reserves management).|
|Continue to use cross-currency swaps as the primary source of reserves funding.||Support a positive carrying cost of reserves assets.||Sixty-four cross-currency swaps were executed in 2005–06 totalling $7.2 billion.|
|Modernize the Currency Act, which provides the legislative basis for the management of the foreign reserves.||Reduce potential for legal risk issues by modernizing the act and increasing the flexibility of investment policy.||Amendments enacted through Budget Implementation Act, June 2005.|
|Continue to review the foreign reserves portfolio investment policy.||Improve the risk/return profile of the portfolio, with the possible inclusion of new asset classes.||An external review of the EFA was completed and will be released publicly in 2006.|
Part III: Programs and Indicators
Part III is divided into three main sections: indicators of the outcome of domestic debt program operations, indicators of cash management activity, and indicators of reserves funding. It also provides information on the distribution of holdings of Government of Canada securities. 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 directly reflect the impact of specific government debt management policies. However, they serve as useful metrics in helping to understand the results and context of debt management initiatives.
Domestic Debt Programs
Measures of outcomes in the area of domestic debt management 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 2005–06, treasury bill and bond auctions continued to be covered and 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, winning more than 95 per cent of bonds offered, except in the case of Real Return Bond auctions, where customers have won more than 45 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 99 per cent and 94 per cent of the turnover of treasury bills and bonds respectively (for more information on the federal debt distribution framework, see www.fin.gc.ca/dtman/2001-2002/dmr02_3e.html#Annex1).
Gross bond program issuance in 2005–06 was $32.4 billion (including issuance through switch buybacks), about $3 billion lower than the $35.5 billion in 2004–05 (see Table 3). Gross issuance consisted of $10.0 billion in 2-year bonds, $9.2 billion in 5-year bonds, $10.0 billion in 10-year bonds and $3.2 billion in 30-year bonds (see Reference Table VIII for more information on bond auctions). In 2005–06, $22.1 billion of bonds matured. Taking into account buybacks and maturities, the stock of outstanding bonds declined by $6.9 billion during the fiscal year to $237.3 billion as at March 31, 2006.
Change in Composition of Federal Market Debt, 2005–061
|April 1, 2005||Receipts /Credits||Payments/Charges||March 31, 2006||Change|
|Payable in Canadian currency|
|Real Return Bonds||22.4||2.13||0.0||24.5||2.1|
|CPP bonds and notes||3.4||0.0||0.3||3.1||-0.3|
|Total domestic debt||416.3||413.9||-2.4|
|Payable in foreign currencies5|
|Euro Medium-Term Notes||1.7||0.0||0.2||1.5||-0.2|
|Total foreign debt||16.5||14.3||-2.2|
|Less: Government’s own holdings7||1.1||17.4||17.3||1.0||-0.1|
|Total market debt||431.8||427.3||-4.5|
|Obligations related to capital leases||2.9||0.1||0.1||2.9||0.0|
|Unamortized discounts and premiums||-6.3||3.5||4.0||-6.8||-0.4|
|Cross-currency swap revaluation||-0.9||1.3||-2.3||-1.3|
|Total unmatured debt||427.4||421.1||-6.3|
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 The comparative figures have been restated to reflect the current year’s Public Accounts presentation.
2 Includes the regular bond buyback program ($8.6 billion) and the cash management bond buyback program ($8.7 billion). Some cash management bond buybacks in 2005–06 did not reduce maturities in that year, but will in 2006–07.
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, 2006 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.
6 Includes $246.1 million in securities assumed by the Government of Canada on February 5, 2001, on the dissolution of Petro-Canada Limited.
7 Includes a consolidation adjustment for Crown corporations and other entities.
Source: Public Accounts of Canada.
Real Return Bonds (RRBs)
Including the adjustment for the Consumer Price Index (CPI), RRB issuance in 2005–06 was at a level similar to the previous year’s issuance of $2.1 billion, increasing the level of outstanding RRBs from $22.4 billion to $24.5 billion as at March 31, 2006. In 2005–06 the fourth RRB was issued, and had 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 $8.6 billion in 2005–06, consisting of $4.7 billion in 2- and 5-year bonds, $2.6 billion in 10-year bonds and $1.3 billion in 30-year bonds (see Reference Table XII for more information on buyback operations).
Buybacks on a cash basis resulted in $5.3 billion of new benchmarks being issued. Switch buyback operations in 2005–06 resulted in $4.5 billion of new building benchmarks being issued.
The amount of new bonds issued through buybacks on a switch basis does not necessarily equal the amount of old bonds bought back through switch operations because the exchange is not done on par value but on a duration-neutral basis. Chart 8 shows the impact of regular bond buybacks on benchmark sizes in 2005–06.
Treasury Bills and Cash Management Bills (CMBs)
The stock of outstanding treasury bills and CMBs increased by $4.4 billion during 2005–06 to $131.6 billion at March 31, 2006, consistent with the orderly move to a lower fixed-rate share of debt. Over the fiscal year, $309.9 billion in treasury bills and CMBs were auctioned, an increase of $38.4 billion from the previous year (see Table 4). There were $7.5 billion of CMBs outstanding at the beginning of fiscal 2005–06 and $11.8 billion outstanding at the end of the year. Throughout the year, $58.9 billion in CMBs were issued for various short-term maturities. More frequent use of CMBs, as a cost-effective cash management tool, helped smooth fluctuations in cash balances over the year.
Treasury Bill and CMB Program Issuance
|3-month treasury bills||88.1||103.3||117.4||129.7||137.5||140.2|
|6-month treasury bills||38.6||43.1||47.8||51.9||54.5||55.4|
|12-month treasury bills||38.6||43.1||47.8||51.9||54.5||55.4|
|Total treasury bills||165.3||189.5||213.0||233.5||246.5||251.0|
|Total including CMBs||174.3||197.0||236.8||262.4||271.5||309.9|
|Sources: Bank of Canada and Public Accounts of Canada.|
The level of outstanding debt held by domestic retail investors—Canada Savings Bonds and Canada Premium Bonds—decreased from $19.1 billion to $17.3 billion in 2005–06. Gross sales and redemptions were $1.8 billion and $3.6 billion, respectively, for a net reduction of $1.7 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 $17.3 billion.
For more information on Canada Savings Bonds and Canada Premium Bonds, see the annual report of Canada Investment and Savings, the Government of Canada’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 amount of bids received divided by the auction amount. A coverage statistic of one is essential for each auction, and a higher statistic is generally better as it is usually a sign of more aggressive bidding and therefore should typically result in lower borrowing costs. The auction tail is the number of basis points between the highest yield accepted and the average yield. In this case, a smaller auction tail is preferable as it indicates strong bidding and therefore lower borrowing costs.
The terms of participation covering government auctions require more active 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 90 per cent of winning bids) could reach about 2.8 for bond auctions and 2.5 for treasury bill and CMB auctions. Minimum coverage ratios, 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 2005–06, coverage for bond auctions was slightly higher than the 4-year average, while tails for both treasury bill and bond auctions were narrower than the 4-year average, indicating relatively more competitive bidding at auctions (see Table 5).
Performance at Auctions
|Coverage (Ratio)||Tail (Basis Points)|
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.
Two new primary dealers for Government of Canada securities were announced by the Bank of Canada in December 2005 (see www.bank-banque-canada.ca/en/notices_fmd/2005/not091205.html for more information).
In 2005–06 primary dealers (PDs) were allotted about 95 per cent of nominal bond auctions while customers were allotted about 2 per cent and the remaining government securities distributors (GSDs) won approximately 3 per cent (see Table 6). The 10 most active participants bought about 92 per cent of the bonds on average. These percentages show a slight decrease in concentration of primary dealer allotments from the previous year.
Bond Auctions Share of Amount Allotted to Participants
(Excluding Real Return Bonds)
|Top 10 participants||88.7||90.9||92.8||91.5|
|Source: Bank of Canada.|
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 indirectly in buyback operations through dealers rather than participating directly (see Table 7).
Bond Buyback Operations Share of Amount Allotted to Participants
(Excluding Cash Management Bond Buybacks)
|Top 10 participants||94.5||97.4||97.9||96.0|
1 Results may underestimate customer participation. Contrary to treasury bill and bond auctions and switch buyback operations, customers do not have to inform the Bank of Canada about their participation at regular bond 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 and lower liquidity in the secondary market, as many RRB investors are buy-and-hold investors. Allotments to customers increased from about 46 per cent in 2004–05 to 48 per cent in 2005–06 as the primary dealers’ share decreased from the previous year, although unlike in 2002–03 and 2003–04, customers’ share remained below that of the PDs. The 10 most active participants in RRB auctions were allotted 69 per cent of the amount auctioned, which is in line with historical averages (see Table 8).
RRB Auctions Share of Amount Allotted to Participants
|Top 10 participants||63.9||69.0||66.6||69.0|
|Source: Bank of Canada.|
For 2005–06 primary dealers accounted for about 91 per cent of amounts allotted at treasury bill auctions while customers accounted for about 8 per cent and other GSDs accounted for about 2 per cent. The share won by primary dealers increased by about 4 percentage points in 2005–06. In 2005–06 the 10 most active participants accounted for about 94 per cent of amounts allotted at treasury bill auctions, slightly more than in previous years (see Table 9).
Treasury Bill Auctions Share of Amount Allotted to Participants
|Top 10 participants||91.5||93.7||93.6||94.1|
|Source: Bank of Canada.|
Cash Management Bills
Primary dealers are the most frequent participants at CMB auctions. In 2005–06 they 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 from the previous fiscal year to about 3 per cent (see Table 10).
CMB Auctions Share of Amount Allotted to Participants
|Top 10 participants||95.5||99.2||98.1||98.2|
|Source: Bank of Canada.|
The two conventional measures of liquidity and efficiency in the secondary market for Government of Canada securities are trading volume and turnover ratio. These two measures are presented for bonds (Chart 9 and, for international comparison purposes, Chart 10) and treasury bills (Chart 11).
Trading volume and turnover ratios for bond repos (Chart 12) and treasury bill repos (Chart 13) 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 inventories. 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 depth and 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 interest rate futures contracts complements an efficient Government of Canada securities market. A liquid repo market exists for Government of Canada treasury bills and nominal bonds. There are also active futures contracts based on the benchmark 2- and 10-year Government of Canada bonds.
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 hit a record $5,474 billion in 2005–06, a 16-per-cent increase from 2004–05. The average quarterly turnover ratio was 5.1 times the outstanding stock of bonds in 2005–06, compared to 4.2 in 2004–05 (see Chart 9).
With an annual debt stock turnover ratio of 20.1 in 2005, the Government of Canada bond market compares favourably with other major sovereign bond markets, with the exception of the United States (see Chart 10).
The volume of transactions in the treasury bill market was comparable to the previous fiscal year and remains well below the highs in the mid-1990s, when the level of the treasury bill stock was at its peak. In 2005–06, total treasury bill trading volume was $1,491 billion (see Chart 11). The average quarterly turnover ratio increased to 2.97 in 2005–06 from 2.89 in 2004–05, but remains lower than the corresponding measure of government bond market activity.
Both Government of Canada bond repos and treasury bill repos remained active in 2005–06. The total trading volume for Government of Canada bond repos in 2005–06 was $21,201 billion, up from $17,594 billion in 2004–05. The average quarterly turnover ratio for bond repos in 2005–06 was 19.7 times compared to 15.7 times in 2004–05 (see Chart 12). The treasury bill repo market volume in 2005–06 was $3,218 billion compared to $3,582 billion in 2004–05 and the average quarterly turnover ratio dipped to 6.4 from 7.6 in 2004–05 (see Chart 13).
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 jumped to 4.7 million contracts in calendar year 2005, a 56-per-cent increase from 2004. The futures contract based on the 2-year Government of Canada bond (or the CGZ contract), launched in 2004, had a trading volume of only 0.1 million contracts in 2005, and was relaunched in July 2006 after a modification to the contract’s specifications.
Trading by Market Participants
Primary dealers’ share of bond trading in the secondary market decreased slightly in 2005–06 from the previous year while other government securities distributors’ share increased, continuing the trend since 2002–03. The 10 most active participants in the bond secondary market represented about 94 per cent of trading activity (see Table 11).
Bond Trading: Market Share of Participants
|Top 10 participants||95.9||95.1||93.9||94.2|
|Source: Bank of Canada.|
Primary dealers maintained 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 represented about 99 per cent of trading activity (see Table 12). Both measures are in line with the levels seen in recent years.
Treasury Bill Trading: Market Share of Participants
|Top 10 participants||99.5||99.2||99.5||99.3|
|Source: Bank of Canada.|
Receiver General (RG) cash balances, the Government of Canada’s Canadian-dollar balances, are invested in a prudent, cost-effective manner through auctions with private sector financial institutions. Since February 1999, when the Large Value Transfer System was implemented, RG cash balances have been allocated to bidders twice daily through an auction process administered by the Bank of Canada. These auctions serve two main purposes: first, as a treasury management tool, they are the means by which the Government invests its short-term Canadian-dollar cash balances; second, the auctions are used by the Bank to neutralize the net impact of any public sector flows on the financial system.
A portion of the morning auction has been offered on a collateralized basis since September 2002, permitting access to a wider group of potential participants, while ensuring that the Government’s credit exposure is effectively mitigated.
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
RG cash balances fluctuate widely over the year for a variety of reasons. In 2005–06 they reached a peak of $18.3 billion and a low of $1.9 billion (see Chart 14). Cash balances tend to be at their highest during the months of March, April, May and November in anticipation of the large flows related to fiscal year-end as well as the buildup of funds which are typically required to cover large bond coupon and principal maturities on June 1 and December 1.
Average Daily Cash Balances
Average daily cash balances decreased in 2005–06 to $5.6 billion (see Table 13) as a result of the more frequent use of cash management bills (CMBs) as a cash management tool and, to a lesser extent, smaller bond maturities relative to the previous fiscal year. CMBs allow for more flexible short-term borrowing while smaller maturities mean that lower cash balances need to be held in advance of maturities.
Average Daily Receiver General Cash Balances Held at Financial Institutions
|Average daily cash balances||6.1||7.9||8.2||5.6|
|Source: Bank of Canada.|
Collateral arrangements were introduced in 2002 to mitigate the credit risk tied to the deposit of cash balances with counterparties. Participants with approval for uncollateralized bidding limits tend to maximize their uncollateralized lines prior to using their collateralized lines. Generally, at least 20 per cent of the balances are collateralized; however, in months of high balances, the proportion of collateralized balances can exceed 70 per cent (see Chart 15).
Coverage and Tails
In 2005–06, coverage at RG auctions improved from the previous fiscal year for the AM auction, and was above the rolling four-year average (see Table 14). This is a continuation of the trend from 2002–03, when the new RG collateralization framework was introduced to facilitate broader participation in AM auctions (for details on the RG collateralization framework see www.fin.gc.ca/dtman/2003-2004/dmr04_1-eng.asp#Annex2). Coverage for the PM auctions was relatively unchanged.
The wider PM auction tails reflect the reduced number of participants and the different motivation of participants for that auction. The morning auction is a normal market operation, whereas the additional goal of the afternoon auction is the neutralization of Large Value Transfer System balances.
Performance at Receiver General Auctions
|Tail (basis points)||0.91||1.68||1.26||1.76||1.41|
|Tail (basis points)||3.04||3.09||2.96||3.49||3.16|
|Source: Bank of Canada.|
The top 10 participants in the Large Value Transfer System (LVTS), the electronic system for the transfer of large payments, won about 80 per cent of RG auctions on average in 2005–06, while the top 10 non-LVTS participants won about 18 per cent of the amount allotted (see Table 15).
Receiver General Auctions Share of Amount Allotted
Between LVTS and Non-LVTS Participants
|Top 10 LVTS||91.0||76.0||74.3||79.9|
|Top 10 non-LVTS||7.1||23.8||24.3||17.8|
|Source: Bank of Canada.|
Evaluation of the Receiver General Cash Management Program
KPMG LLP was engaged in the winter of 2005–06, through the treasury evaluation program, to conduct a review of the Receiver General cash management program. The evaluation was ongoing at fiscal year-end. When complete, the results and departmental response will be posted on the Department of Finance website.
Cash Management Bond Buyback Program
The cash management bond buyback (CMBB) program helps manage cash requirements by reducing the high levels of cash balances needed for key coupon and maturity payment dates. The program also helps smooth variations in treasury bill auction sizes over the year.
In 2005–06 the total amount of bonds repurchased through the CMBB program was $8.7 billion, compared to $12.9 billion in 2004–05. In 2004–05 and 2005–06 the CMBB program reduced the size of the 2005 June 1, September 1 and December 1 bond maturities by about 30 per cent, from a total outstanding of $31.0 billion to $21.9 billion (see Chart 16). The CMBB reduction in the outstanding size of these maturities is in addition to the $2.7-billion reduction previously achieved through the regular buyback program. Together, the CMBB and regular buyback operations reduced the June, September and December 2005 maturities by 35 per cent.
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 2005–06, the cost of carrying RG cash balances was a net cost of $9.4 million, compared to a net cost of $13.1 million for the prior fiscal year (see Chart 17). This improvement was achieved, during an environment of relatively stable yield differentials, by keeping lower balances and maintaining large balances for shorter periods of time. This was made possible by a more active use of short-term cash management bills.
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 associated with large operations. The profile of treasury bill operations continued to be smooth in 2005–06, with net new issuance ranging from -$2 billion to +$3 billion per operation, with a standard deviation of $1.4 billion (see Table 16). Gross issuance was also reasonably smooth, with a standard deviation of $1.3 billion (see Chart 18).
Profile of Net Size of Treasury Bill Issues
|Range||-3 to 3||-4 to 4||-2 to +6||-2 to +4||-2 to +3|
|Standard deviation of
new issues less maturities
|Source: Bank of Canada.|
Audits and Evaluations
Audit of Administrative Controls Over the Domestic Debt
The audit of administrative controls over the domestic debt was completed in July 2004. While many aspects of the administrative controls were found to be operating effectively, a number of opportunities were observed and many recommendations to strengthen procedures have been pursued
for more information).
Foreign Currency Debt Programs
Foreign currency debt is used to fund the foreign exchange reserves, which are held in the Exchange Fund Account. There are a variety of instruments available to meet foreign currency funding requirements. In 2005–06, the sources of reserves funding used were Canada bills and cross-currency swaps.
The Report on the Management of Canada’s Official International Reserves
, available at www.fin.gc.ca/toc/2006/oir06_-eng.asp, provides information on the objectives, composition and performance of the reserves portfolio.
In 2005–06 the level of outstanding Canada bills increased from $3.9 billion (US$3.2 billion) to $4.7 billion (US$4.0 billion). In 2005–06 Canada bills were issued, on average, at an all-in cost of US$ LIBOR (London Inter-Bank Offered Rate) less 28 basis points, which was generally in line with the levels achieved in recent years.
Foreign Currency Bonds
In 2005–06, no new foreign currency bonds were issued, while a total of $1.8 billion (US$1.5 billion) matured. The total decline in the stock of outstanding foreign bonds, including exchange rate changes, was $2.3 billion. The total outstanding was $7.6 billion (US$6.5 billion) at the end of 2005–06.
There were no new Canada note issues or maturities in 2005–06, while a total of $0.6 billion (US$0.4 billion) matured. The total outstanding was $0.5 billion (US$0.4 billion) at the end of 2005–06.
Euro Medium-Term Notes
In 2005–06 no new Euro Medium-Term Notes were issued. The total outstanding decreased from $1.7 billion (US$1.5 billion) to $1.5 billion (US$1.3 billion).
In 2005–06, $7.2 billion (US$6.1 billion) was raised to fund the foreign exchange reserves by entering into 64 cross-currency swaps at an average cost of US$ LIBOR less 35 basis points, which was generally in line with the levels achieved in recent years. A total of $3.9 billion (US$3.3 billion) of swaps matured in 2005–06. At the end of the 2005–06 fiscal year, the outstanding amount of cross-currency swaps totalled $26.2 billion (US$22.4 billion) (see Reference Table XI for transaction details). Taking into account the effect of cross-currency swaps, foreign currency obligations were 9.4 per cent of the Government’s total market debt.
A collateral management framework is used to mitigate credit risk exposure to financial institution counterparties associated with cross-currency swap transactions. Under this framework, high quality collateral (e.g. cash, treasury bills) is pledged by counterparties when the net market value of their contracts with the Government of Canada exceeds specified limits. Over the fiscal year, given the strength of the Canadian dollar, most of the swaps were "in the money," meaning that the market value of the swaps had increased. At the end of the 2005–06 fiscal year, the value of collateral posted by counterparties was $1.2 billion (US$1.0 billion).
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. Diversification of the investor base is pursued 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 foreign borrowings.
In 2005, based on Statistics Canada surveys, life insurance companies and pension funds accounted for the largest share of holdings of Government of Canada market debt (22.1 per cent), followed by public and other financial institutions such as investment dealers and mutual funds (21.9 per cent) and chartered banks (14.6 per cent) (see Chart 19). 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.
Gross debt is made up of unmatured debt and other liabilities. At the end of March 2006, gross debt totalled $702.5 billion, down $2.5 billion from the previous year and down $11.1 billion from its peak of $713.6 billion in 1999–2000.
Market debt is the portion of gross debt that is funded in the capital markets. Market debt consists of marketable bonds, treasury bills, foreign-currency-denominated bonds and bills, retail debt, and bonds held by the CPP. Foreign currency debt is issued on an opportunistic basis. At March 31, 2006, market debt outstanding was $427.3 billion, down $4.5 billion from the previous year (see Chart A1).
Market Debt Adjustments
Market debt adjustments include unamortized premiums, discounts and commissions on market debt, cross-currency swap revaluations and capital lease obligations.
Other liabilities include liabilities held outside the capital markets. They include obligations to public sector pension plans, accounts payable and accrued liabilities and allowances. In 2005–06, other liabilities amounted to $281.3 billion, up $3.8 billion from the previous year.
Net debt is gross debt minus financial assets. Financial assets include cash, foreign exchange accounts and loans. Net debt declined by $12.7 billion from $549.6 billion in 2004–05 to $536.9 billion in 2005–06. Financial assets increased by $10.2 billion to $165.6 billion.
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 $13.2 billion, from $494.7 billion in 2004–05 to $481.5 billion in 2005–06. Non-financial assets increased by $0.5 billion to $55.4 billion.
Annex 2: Completed Treasury Evaluation Reports, 1992–2006
|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|
|Funds Management Governance Framework1||2004|
|Retail Debt Program1||2004|
|Borrowing Framework of Major Federal Government-Backed Entities1||2005|
|Receiver General Cash Management Program2||2006|
|Exchange Fund Account Evaluation2||2006|
|1 Available at www.fin.gc.ca.
Source: Department of Finance.
Annex 3: Glossary
One hundredth of a percentage point (0.01 per cent). Basis points are often used to measure changes in or differences between yields on fixed-income securities, since these often change by very small amounts.
Specific issue which is typically the most liquid bond within each range of maturities. It is considered by the market to be the standard against which all other bonds issued in that term area are evaluated.
Price at which an individual is willing to buy a security or commodity.
The standard differential between the bid price (at which the holder can sell) and the offer price (at which the holder can buy). On occasion this can be quite large and depends on the underlying price, liquidity, volatility and a number of other factors.
The shortfall between government annual revenues and annual budgetary expenses.
compound interest 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:
The fund of foreign-currency-denominated assets which is maintained by the Government of Canada for the purpose of promoting order and stability of the Canadian dollar in the foreign exchange market. This account facilitates the selling of foreign exchange (buying Canadian dollars) when there is downward pressure on the currency and conversely is the recipient of foreign exchange inflows (selling of Canadian dollars) when there is upward pressure on the value of the Canadian dollar.
Measures the difference between the cash inflows and outflows of the Government’s Receiver General account. In the case of a financial requirement, it is the amount of new borrowing required from outside lenders to meet financing needs in any given year.
foreign exchange reserves:
Foreign exchange reserves are the foreign currency assets (e.g. interest-earning bonds) held 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 and certain clients.
government securities distributor:
An entity (i.e. an investment dealer or bank) that is authorized to bid at Government of Canada auctions and through which the Government distributes Government of Canada treasury bills and marketable bonds.
A persistent rise in the price of goods, services and factors of production over an extended period of time, as measured by a price index such as the Consumer Price Index or the gross domestic product deflator; it is the percentage change in the price index.
Consists of unmatured debt, or market debt, and liabilities to internally held accounts such as federal employees’ pension plans.
Large Value Transfer System:
An electronic funds transfer system introduced in February 1999 and operated by the Canadian Payments Association. It facilitates the electronic transfer of Canadian-dollar payments across the country virtually instantaneously.
London Inter-Bank Offered Rate. The rate of interest offered by commercial banks to other banks for cash deposits on the London Inter-Bank Market.
An interest-bearing certificate of indebtedness issued by the Government of Canada, and having the following characteristics: bought and sold on the open market; payable in Canadian or foreign currency; subject to call or redemption before maturity; having a fixed date of maturity; interest payable either in coupon or registered form; and face value guaranteed at maturity.
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.
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.
Price at which an individual is willing to sell a security or commodity.
overnight rate; overnight financing rate; overnight money market rate; overnight lending rate:
An interest rate at which participants with a temporary surplus or shortage of funds are able to lend or borrow until the next business day. It is the shortest term to maturity in the money market.
Member of the core group of government securities distributors that maintains 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.
The market in which issues of securities are first offered to the public.
regular interest 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 financial transaction in which a dealer in effect borrows money by selling securities and simultaneously agreeing to buy them back at a higher price at a later time.
reverse repo; reverse repurchase agreement:
A financial transaction in which a dealer purchases securities with an agreement to resell them at a higher price at a specific future date. This is essentially a loan of the security at a specific rate.
A market where existing securities trade after they have been sold to the public in the primary market.
Volume of securities traded as a percentage of securities outstanding.
The conceptual or graphic representation of the term structure of interest rates. A normal yield curve is upward sloping, with short-term rates lower than long-term rates. An inverted yield curve is downward sloping, with short-term rates higher than long-term rates. A flat yield curve occurs when short-term rates are the same as long-term rates.
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
1. The Report on the Management of Canada’s Official International Reserves, available at www.fin.gc.ca/toc/2006/oir06_-eng.asp, provides further information on the performance of the reserves portfolio. [Return]
2. These entities comprise six "Borrowers": four Crown corporations (the Business Development Bank of Canada, Canada Mortgage and Housing Corporation, Export Development Canada and Farm Credit Canada) and two non-Crown corporations (the Canada Housing Trust and the Canadian Wheat Board). While each Borrower issues debt in its own name, all of their debt issues are backed by the full faith and credit of the Government. [Return]
3. These entities comprise six "Borrowers": four Crown corporations (the Business Development Bank of Canada, Canada Mortgage and Housing Corporation, Export Development Canada and Farm Credit Canada) and two non-Crown corporations (the Canada Housing Trust and the Canadian Wheat Board). While each Borrower issues debt in its own name, all of their debt issues are backed by the full faith and credit of the Government. [Return]
4. Public sector flows include federal government receipts and disbursements and Bank of Canada transactions. [Return]
5. Reported at par value using exchange rates from March 31, 2006. [Return]