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Government Bond Market Development – Managing Interdependencies – . June 17, 2003 Johannesburg, South Africa Noritaka Akamatsu Financial Sector Operations & Policy Dept. The World Bank. Why develop Government Bond Market?. Capital markets in general

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Government bond market development managing interdependencies

Government Bond Market Development – Managing Interdependencies –

June 17, 2003

Johannesburg, South Africa

Noritaka Akamatsu

Financial Sector Operations & Policy Dept.

The World Bank

Why develop government bond market
Why develop Government Bond Market? Interdependencies –

Capital markets in general

  • complement bank financing and contribute to the development of multi-layered financial systems.

  • mobilize domestic long-term savings to finance investment for growth without excessively relying on external borrowing.

  • thus, reduces risks or enable management of those and makes the growth sustainable.

    Government bond market in particular

  • is a backbone of fixed-income markets

  • provides a number of positive externalities for overall debt market development.

Some externalities
Some externalities Interdependencies –

Macro level:

  • non-inflationary funding of budget deficit,

  • smooth transmission of monetary policies

    Micro level:

  • support development of the rest of the debt market by offering pricing benchmarks;

  • stimulate development of financial infrastructure, products, and services;

  • Enable management of exposure of portfolios to interest rates and exchange rates (derivatives).

The necessary environment
The Necessary Environment Interdependencies –

  • Macroeconomic stability, low inflation

  • Fiscally sustainable growth

  • Credible commitment of the government

  • Adequate financial sector development

    • Liberalization of the financial system, particularly that of interest rate

    • Competition among intermediaries

    • Solvent financial system

Recent efforts to foster government bond market
Recent efforts to foster Interdependencies – Government Bond Market

The objectives are to:

  • provide a strategic and comprehensive vision.

  • emphasize medium- and long-term markets, and

  • highlight linkages with other markets.

Govt bond market as a place of interaction
Govt Bond Market as a place of interaction Interdependencies –

  • Govt bond market, like any other financial market, is NOT a single institution but a place of interaction among participants, supported by a complex set of institutions.

  • Everything depends on everything else, and no single party can dictate the development process.

  • Requires a political commitment.

  • An “opportunistic strategy” is needed to manage a complex set of chicken-and-egg problems.

    Q. Where to start? How to sequence?

Six building blocks
Six Building Blocks Interdependencies –

  • The Issuer (i.e., the government)

  • Investors

  • Market intermediaries

  • Trading and settlement infrastructure

  • Legal and regulatory infrastructure

  • Instruments

Government as the issuer supply of gss
Government as the Issuer Interdependencies – - Supply of GSs -

  • There must be bonds in order for a bond market to exist and develop. The government must:

    • have a fiscal policy stance which enables sustainable issuance of government bonds,

    • be adequately empowered to borrow from the domestic market (i.e., borrowing authority),

    • be capable of managing the borrowing well (together with the central bank), and

    • be able to manage the cash and debt efficiently.

  • Fiscal policy should be separated from the monetary policy.

  • Clear mandates and governance of debt manager.

Public debt management and primary market
Public Debt Management and Primary Market Interdependencies –

  • Two key objectives of government debt management

    • Raise a needed amount of funds when needed, and

    • Do so price-competitively accounting for risks.

      • The gov’t should be a price taker (because otherwise, the secondary market will not develop).

      • Reserve requirement for banks should not be a tool to generate demand for gov’t bonds.

  • Govt bond market development should be the third objective.

  • Standardize instruments, regularize and announce issuance calendar, and create benchmarks.

Govt cash management and money market
Govt Cash Management and Money Market Interdependencies –

  • Deep and liquid money market and upward sloping yield curve enable trading along the yield curve and encourage demand for long-term govt bonds.

  • Open market operations by the Central Bank and borrowing operations by the government need to be coordinated.

    • i.e., requires sound cash and debt management by the government.

  • Sound management of excess reserves of banks by the Central Bank is required.

Public debt management and primary dealer system
Public Debt Management and Primary Dealer System Interdependencies –

  • Obligations for PDs should be designed to be useful for the debt manager to meet debt management objectives. Typical obligations for PDs include:

    • Always participate in primary auctions;

    • Market making, i.e., maintaining price quotes for buy and/or sell and a high trading volume through the prices it quotes.

  • At the same time, benefits for PDs from privileges should outweigh costs from the obligations. Typical privileges include:

    • Exclusive right to participate in the primary auction

    • Exclusive counterparties for Central Bank operations

  • Needs a reliable mechanism to monitor PDs’ market making performance (e.g., trading platform).

Investors and intermediaries

Investors and Intermediaries Interdependencies –

Institutional investors source of demand
Institutional Investors Interdependencies – - Source of Demand -

  • A critical source of demand for long-term govt securities.

    • Life insurance, pension funds, mutual funds

    • Mandatory insurance (e.g., auto insurance, mortgage indemnity insurance), second pillar pensions

  • Investment regulations for pension funds and insurance companies regarding their portfolio allocation should be made conductive to investment in bonds (usually not a problem with govt bonds but often with corporate bonds).

To generate liquidity
To generate liquidity Interdependencies – ……

  • There need to be investors with different investment / trading needs (e.g., banks, institutional investors, non-financial companies. Individuals?).

  • Prudential regulation and risk management requirements (including adoption of mark-to-market accounting) should be conductive to generation of liquidity in the market

Prudential regulation risk management
Prudential Regulation & Risk Management Interdependencies –

  • Institutional investors are typically required to:

    • invest in liquid and creditworthy instruments

    • diversify the portfolio, and

    • mark-to-market the portfolio to manage risk and provide fair market value for the beneficiaries.

  • Mark-to-market requires:

    • adoption of proper accounting standards, and

    • reliable market price information.

  • Both depends significantly on the existence of liquid secondary market for benchmarks.

Institutional investors and trading market
Institutional Investors and Trading Market Interdependencies –

If there are developed institutional investors,

  • trading market architecture would need to accommodate their business needs.

    If there aren’t,

  • banks as dealers would likely be the primary investors as well as intermediaries.

  • Inter-dealer broker (IDB) or inter-dealer system instead of multi-dealer system is likely to be a trading market architecture.

Trading and market transparency

Trading and Market Transparency Interdependencies –

Bond market transparency information systems
Bond Market Transparency & Interdependencies – Information Systems

  • Reliability and transparency of market “price” is crucial.

    • benchmark for pricing in the primary market to ensure smooth absorption.

    • enables investors to obtain fair value, thus encouraging wider and more active participation in the market

    • effectuates Mark-to-Market valuation of portfolio and collateral for risk management, mutual funds, etc..

      Q. How can a critical mass of transactions be captured to give reliable market price information back to the market?

    • Information system, trading system or settlement system?

    • Mandatory reporting of every transaction?

Transparency required
Transparency required Interdependencies –

Not all transparencies are good.

  • Post-trade price and volume information for all.

  • As equal access as possible to “pre-trade price” information at least for all “direct” market participants.

  • How about identity of market participants? Pre-trade or post-trade?

How to achieve the transparency
How to Achieve the Transparency Interdependencies –

  • Organize the trading market to the extent possible.

    • Standardize pricing formula and other transaction conventions.

    • Electronic trading systems, IDBs

      Q. Can electronic market attract critical mass of trading in benchmarks? Fragmentation if multiple platforms?

  • OTC market - how do we know what the market price is?

    • Competing private information vendors (e.g., Reuters, Telerate, Bloomberg, Quick, etc.). But fragmentation?

    • Reporting “requirement” to a central point. To whom? Not a private info vendor. Bond dealers’ association?

  • Settlement system can gather trade information?

    • if standardize settlement cycles and shorten it to be Real Time (G-G) DVP. If not???

Transparency and self regulation in bond market
Transparency and Self-Regulation in Bond Market Interdependencies –

  • Bond dealers’ association can standardize pricing formula and other trading business conventions (e.g., master repo agreement) to enhance transparency and liquidity.

  • Can self-regulation work in bond market?

    • Bond dealers’ association: a trade association or an SRO?

    • Reporting requirement to a bond dealers’ association. Cooperation with private information venders?

    • Does it have a technical capability?

Electronic bond trading
Electronic Bond Trading Interdependencies –

  • Equity market has been organized in exchanges while bond market has operated OTC. Why?

  • More recently, the architectures of the two markets are converging with respect to government securities.

    • Demutualization of stock exchanges and emergence of ATSs and ECNs are making the equity market architecture “open and competitive”.

    • The possibility of DVP with end-to-end STP with dematerialized securities is making trading of government bonds through a common trading platform more possible.

  • Electronic trading systems

    • Inter-dealer system/IDB vs. multi-dealer system

Trading market
Trading Market Interdependencies –

  • Organized trading may be possible and useful only for benchmarks. Why?

  • Big players want “anonymity” to avoid impact cost.

    • Bond Exchange?? NYSE, NASDAQ used??

    • Electronic trading systems?

    • Inter-Dealer Broker (IDB).

  • There should first be a DVP settlement arrangement. Why?

Trading market and institutional investors
Trading Market and Institutional Investors Interdependencies –

  • II’s may wish to access the trading platform directly so that they can avoid intermediation cost.

  • If II’s trade directly among them, dealers (e.g., banks) may lose significant business.

  • It may be good for the II’s. But it is not entirely clear whether it will be good for market development, because:

    • banks as dealers may be discouraged to make market, and

    • viability of a primary dealer system may be reduced.

Settlement systems

Settlement Systems Interdependencies –

Efficiency in settlement
Efficiency in Settlement Interdependencies –

  • Underpins cost-efficiency of transactions and thus “competitiveness” of the market.

  • Efficiency-Safety tradeoff

    • RTGS vs. netting

  • Capital/liquidity efficiency (i.e., efficient use of capital/ liquidity required to run a settlement system)

    • Use of collateral instead of capital/liquidity

    • But the collateral has opportunity cost and must be reasonably liquid

    • Cross margining / collateralization (e.g., derivatives and spot markets)

  • DVP first and maybe central counter-party (CCP) later.

Links between trading and settlement systems
Links between Trading and Settlement Systems Interdependencies –

  • An anonymous trading system needs to be supported by DVP settlement because:

    • each market participant must minimize counter-party risk when there is no CCP; and

    • the CCP needs to manage counter-party risk vis-à-vis its participants when there is a CCP.

  • In an emerging market, a CSD was often created as part of a monopoly stock exchange while that for gov’t securities is often operated exclusively by the central bank. Is there room for consolidation?

  • Straight through processing (STP)

    • Single entry point

    • Mark-to-market valuation of collateral

London Interdependencies –








Monte Titoli





Nasdaq Europe


















Institutional framework
Institutional Framework Interdependencies –

  • Institutions can be linked or integrated

    • Clearing House / Central counterparty (CCP)

    • Central Securities Depository (CSD)

    • Custodians

    • Registrars

  • The processing should be as straight through (STP) as possible regardless of the combination.

  • Governance of the body matters in deciding on integration.

    • CPSS-IOSCO Recommendations for Securities Settlement Systems

Money settlement rtgs vs netting
Money Settlement Interdependencies – RTGS vs. Netting

  • RTGS or netting (by novation with a CCP) - which is better?

    • Efficiency-Safety tradeoff: RTGS eliminates systemic risk while requiring liquidity which is often to be provided by the central bank. Netting reduces the liquidity requirement while accumulating systemic risk.

    • CCP substantially reduces, if not eliminates, a need to assess creditworthiness of the counterparty.

    • Collateral requirements as functions of trading volume

  • Shortening of the settlement cycle to reduce systemic risk and market risk.

    • Settlement cycle is moving toward T+1

    • Real time DVP for government securities?

Legal and regulatory framework
Legal and Regulatory Framework Interdependencies –

  • Debt management law

    • The borrowing authority and its delegation

    • Net borrowing limits

    • (disclosure)

  • Primary market regulation

    • Participants of the primary market

  • Secondary market regulation

    • Participants of the secondary market

    • Trading platforms, inter-dealer brokers

    • Clearance & settlement system (incl. repos, collateral)

    • Self-regulation

Self regulation in bond market
Self-Regulation in Bond Market Interdependencies –

Would Self-Regulation viable in bond market?

  • The monopoly organized market.

    • Good for transparency. But efficient architecture?? Government securities vs corporate bonds

  • Competitive organized markets

    • Compete among them and with OTC. I.e., participants can go anywhere if it does not like stringent rules by a market operator. => Hard to enforce rules.

  • OTC market

    • Bond dealers’ association: “trade association” or SRO? What is the difference?

    • Self-regulation by regulation of the Regulatory Authority?

Other important tasks
Other Important Tasks Interdependencies –

  • Rationalization of taxation of trading of and investment in debt and equity securities and derivatives (neutral and symmetric capital income taxation).

  • Standardization of repo transactions (e.g., adoption of BMA-ISMA model of master agreement).

  • Establishment of derivatives market to provide hedging instruments for dealers and investors.

  • Legal and regulatory foundations and technical capability for CSD lending and borrowing (with STP-based mark-to-market valuation of collateral).

  • Government debt management for government securities.

  • Credit rating for sub-sovereign and corporate bonds including SOE bonds.

  • Etc., etc..

How should reform plans be prioritized

Lowering of risks and costs Interdependencies –










How should reform plans be prioritized?

Depending on each country’s circumstances

- size of its economy - Trading volume

- sophistication of its financial system - Number of market participants

- its investor profile - etc.

Comprehensive approach
Comprehensive Approach Interdependencies –

Bond Market Committee

  • to be led by MOF and Central Bank at high level.

  • to be participated by

    • securities regulator,

    • bond market association of trading market operator

    • settlement system operator,

    • dealers,

    • institutional investors and asset managers

  • To manage this complex set of chicken-and-egg problems.

  • Political commitment and high level leadership by MOF and Central Bank crucial.

Task forces
Task Forces Interdependencies –

  • Primary market issuance;

  • Secondary market trading mechanism and architecture;

  • Delivery versus payments (DVP) and settlement systems;

  • Tax, accounting and regulatory impediments;

  • Market information systems;

  • Standardization of trading practice and conventions including repo master agreement market

  • Repo clearing and bond lending;

  • Dderivatives market; and

  • Treasury and debt management.

Thank you

Thank you ! Interdependencies –

Noritaka Akamatsu