A problem others would kill for
It has been a roller-coaster decade for Robert Stheeman at the UK’s Debt Management Office as the financial crisis has put a massive strain on the public finances. He tells IFR how he plans to handle the challenges as deficits start to fall.
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When Robert Stheeman took over as chief executive of the UK’s Debt Management Office in 2003, the British government was looking to sell £23bn worth of Gilts. Just six years later and he was tasked with raising £242bn of Gilts and Treasury notes. He earned his spurs managing a remit that has now grown to a total stock of outstanding debt of £1,366bn.
In the latest Budget, Chancellor George Osborne set out public finance forecasts that indicate a gross financing forecast of £151bn, which falls steadily over the following years to reach £77bn in the 2018/19 fiscal year.
“In other words, it is on a declining trend but those numbers would suggest to you and me that we are going to be in business for a little time yet,” Stheeman said with characteristic understatement. The DMO’s challenge over the coming years will continue to one of “debt management during a period of fiscal consolidation”, he said.
“We have this overarching debt management objective, which is about minimising over the long term the costs of meeting the government’s financing needs. That underpins our entire approach, so each year we have to assess – and these are judgements – the costs and risks associated with different patterns of debt issuance.”
This is DMO-speak for juggling the needs of investors along the maturity spectrum. Stheeman acknowledges that the challenge is to ensure investors feel there will be sufficient liquidity in the market.
“We are probably the only sovereign borrower in the world that is able to issue at key benchmark maturities all the way out and beyond 50 years,” he said. In the fiscal year just ended the DMO issued benchmarks with five, 10, 30, 40 and 55-year maturities.
“Clearly, with a declining borrowing requirement three or four years down the road we will need to assess very carefully where we want to build up benchmarks,” he said, adding that if there was less cash to raise there was less need to raise money in every single maturity.
“We will have to make choices in the future with smaller borrowing requirements about which maturities we wish to tap. The cost and the shape of the yield curve is important but [so is] the sense of ‘what does the market need?’”
As far as debt management challenges go, this is a “luxury problem”, according to Lee Cumbes, head of European SSA DCM at Barclays, a Gilt-edged market-maker for the DMO.
“They have proved that they can issue through challenging periods and often with spectacular success. Over the course of the last financial year, four out of the five deals they did were 55-year maturities.”
The UK has been at the forefront of the trend towards lengthening the debt portfolio. Back in 2000, when debt issuance was just £12bn, the DMO did not issue a single short-term Gilt.
In its latest remit published on Budget day, the DMO announced that a larger percentage of issuance would go into long conventional Gilts than in previous years – almost 26% – at the expense of shorts, which would be five percentage points lower than was the case two years ago.
“We are explicitly saying we want to maintain a relatively high proportion of long-dated fixed-rate exposure and we want to maintain this long average maturity in our debt portfolio,” Stheeman says.
“If we have this nirvana of issuing only £70bn – and trust me ‘only’ is a relative term – we will have to consider very carefully what key maturities we choose … in order for us to be confident we have got [investors’] loyalty and their interest in the Gilt product for a long time to come.”
One banker points out that UK sovereign debt is still a pretty sizeable market. The Bank of England has ended up holding a lot of Gilts and “there is always the option that they sell into a market that wasn’t functioning properly”.
The Chancellor’s decisions – announced in the recent budget – to end the obligation on pensioners to buy an annuity and to launch high-interest rate short-dated National Savings & Investment bonds aimed at retirees looking to invest their pension money took the debt market by surprise.
Sales are expected to raise £13bn for the Exchequer over and above the usual NS&I products, increasing demand at the short end of the curve. As Marc Ostwald at Monument Securities pointed out, that move combined with lower demand from annuity providers at the long end was likely to continue to steepen the curve, as pensions saving had been “partially shifted to the front end”.
But this impact is likely to be overshadowed by the impact of upbeat economic data and speculation of a hike in interest rates by the Bank of England.
“Expectations of interest rate hikes are driving the Gilt market out to the 10-year part of the curve,” said Anthony O’Brien, co-head of European rates strategy at Morgan Stanley. “Investors are quite impressed by the recovery in the UK. Only a year ago we were talking about triple dip and the way they are showing their appreciation is by pushing yields higher.”
Stheeman says short-term moves on yields will not alter the DMO’s strategy. “We are not trying to second guess where we feel yields might end up,” he said. “Nobody ever got rich by listening to a yield prediction from me. What we are trying is to observe the market as we see it and analyse it for structural demand in certain areas.”
The DMO has set out its timetable for Gilt issuance in the current year with 41 auctions, of which 26 will be for conventional fixed-rate Gilts including 10 long-dated issues, and 15 index-linked issues.
Demand for index-linked Gilts is certain to be boosted by investors looking to protect themselves from rising inflation and interest rates.
The reopening of the 2068 syndicated linker in January attracted record demand, with £12.5bn of interest over the 60-minute bookbuilding allowing Stheeman to increase the deal size by £750m to £4.75bn.
“We are fortunate in as much as the UK-based investor base is dominated by the domestic pension fund industry, which has strong demand for long-dated assets, both nominal but also inflation-linked, to hedge the inflation-linked liabilities that pension funds and some life insurance companies have,” he said.
The DMO is cutting the number of syndicated deals to four this year – one per quarter – from eight two years ago, prompting speculation of strong demand from investors who favour big liquidity events.
“The fewer the deals, the bigger events they become,” said Cumbes at Barclays. “We still see a lot of excitement around syndications as liquidity is delivered to the market in size. These rarer occasions will attract bigger interest.”
Syndications were only introduced as a regular part of the DMO’s issuance programme in 2009, at a time when borrowing needs rose dramatically. “As the overall borrowing requirement declines, arguably the need to use syndication just for that reason begins to decline,” Stheeman said.
He acknowledged that liquidity-driven investors like syndications because of the large liquidity they look for in auctions.
“In a world where we are issuing less than £100bn we would have to think carefully about the role of syndication. I am not saying we won’t do them, and I am not saying we will do them, but we will have to think carefully.”
One challenge that Stheeman is looking forward to the first issue of sukuk Gilts, which is expected to take place later this year after a period of prolonged speculation.
He says the DMO is working with the Treasury on a number of technical ,including identifying suitable assets and examining the need for any legislative changes.
“There are so many things that need to fall into place but there is nothing to suggest we are anything but on track for issuance this year. In a perfect world we would like to see it done it sooner and no one wants to see these things drag on indefinitely.”
Cumbes says the market will be very interested in the investment diversification possibilities. “It’s a more novel product in the European sovereign context, where the UK is offering a rarity.”
Stheeman echoes that, saying it would benefit London as a centre for Islamic finance. “If we believe it has benefits, we would rather see those benefits realised sooner rather than later.”