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Section 1: Annual Performance Statement

Section 1: Annual performance statement

The 2019-20 Annual Performance Statement of the Australian Office of Financial Management (AOFM) is presented as required under paragraph 39(1)(a) of the Public Governance, Performance and Accountability Act 2013 (PGPA Act).

In my opinion as accountable authority of the AOFM the statement accurately reflects the performance of the Australian Office of Financial Management, is based on properly maintained records, and complies with subsection 39(2) of the PGPA Act.

Rob Nicholl

Chief Executive Officer

24 September 2020

Purpose

The AOFM’s purpose is to ensure the Government’s debt financing needs are met each year while managing the cash, debt and other portfolios over the medium‑long term at low cost subject to acceptable risk. The AOFM takes into account the potential for its operations to impact domestic financial markets.

During 2019‑20 the agency commenced implementation of two investment programs on behalf of government; the Australian Business Securitisation Fund (ABSF) and the Structured Finance Support Fund (SFSF). The ABSF is a $2 billion investment fund with a policy aim to enhance access to finance for SMEs through targeted investments in the securitisation market (with a specific focus on smaller lenders). The SFSF was implemented as part of the Government’s Coronavirus Economic Response Package. It provides for up to $15 billion to ensure continued access to funding markets by SME lenders impacted by the pandemic. This, in accordance with the mandate, is being achieved through targeted government investments in structured finance markets.

The AOFM has adopted three key objectives to achieve its purpose:

  • meet the Budget financing task while managing the trade‑offs between cost and risks for the cash and debt portfolios over the medium‑long term;
  • facilitate government cash outlay requirements as and when they fall due by managing liquidity risk; and
  • be a credible custodian of the Australian Government Securities (AGS) market and other portfolio responsibilities, including the ABSF and SFSF.

The AOFM balances cost and risk considerations but its overriding aim is to ensure that the financing requirements of government are able to be met in full and on time. The AOFM has minimal appetite for failure in any function associated with debt issuance, settlement and cash management. The design and conduct of core business processes (including business continuity arrangements) reflects this risk appetite.

The AOFM monitors its performance against the performance indicators presented in Table 1, sourced from the AOFM’s Corporate Plan 2019‑20 and Portfolio Budget Statements 2019‑20. Sections 2 and 3 of this part of the Annual Report provide detail on a range of outcomes important to the achievement by the AOFM of its annual and longer‑term aims. This detail is provided separately to the Performance Statement because it is aimed at financial market participants as the relevant audience. Performance indicators for the two investment programs (the ABSF and SFSF) are not included in this Annual Report but indicators have been developed for reporting purposes next year. These indicators are published in the AOFM’s corporate plan for 2020‑21 (published on the AOFM website).

Table 1: Performance Information 2019 20

Performance Indicator(a)

Measure (b)

Objective 1: Meet the budget financing task in a cost effective manner subject to acceptable risk

1. Term issuance

Shortfall in volume ($) between actual Treasury Bond issuance and planned issuance announced at the Budget and subsequent release

2.1 Financing cost (portfolio)

The cost of the long term debt portfolio compared to the 10 year average of the 10 year bond rate.

2.2 Financing cost (issuance)

The cost of Treasury Bond issuance over the past 12 months compared to the average 10 year bond rate over the same period.

3. New issuance yields

Weighted average issue yield at Treasury Bond and Treasury Indexed Bond tenders less prevailing secondary mid market yields.

Objective 2: Facilitate the government’s cash outlay requirements as and when they fall due

4. Use of the overdraft facility

Number of instances the RBA overdraft facility was utilised to the extent that it required Ministerial approval during the assessment period.

Objective 3: AOFM is a credible custodian of the AGS market and other portfolio responsibilities

5. A liquid and efficient secondary market

Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds.

6. Market commitments

Number of times the AOFM failed to take actions consistent with public announcements.

Performance Results 2019-20

Objective 1: Meet the budget financing task in a cost effective manner subject to acceptable risk

Indicator 1

Term Issuance: Shortfall in volume ($) between actual Treasury Bond issuance and planned issuance announced at the Budget and subsequent releases

Target

Zero

Result

Target met

In 2019‑20, the AOFM issued $128.2 billion of Treasury Bonds, compared to a planned $55.0 billion. The AOFM also issued $1.65 billion of Treasury Indexed Bonds, compared to a planned $2.0 to $2.5 billion. There was no shortfall between actual and planned issuance announced at the Budget and subsequent releases. Issuance of Treasury Bonds was well in excess of the planned amounts. This reflects a significant unforeseen increase in financing needs due to the Government’s coronavirus related fiscal response. Deferral of the 2020‑21 Budget from May to October 2020 meant that the AOFM was unable to update a planned gross annual issuance program to reflect the escalation in the financing task (an official financing task was not available until after the end of the year). The Treasurer provided the first official update as part of an Economic and Fiscal Update Statement in July. Prior to this the AOFM had been taking the approach of providing issuance guidance in the form of a weekly rate of issuance, which was updated several times as better information became available. The financing task in any year comprises: funding for maturing AGS; the Budget deficit; and off‑Budget funding requirements.

Indicator 2.1

Financing cost (portfolio): The cost of the long‑term debt portfolio compared to the 10 year average of the 10‑year bond rate

Target

Lower

Result

Target met

The effective yield of the long term debt portfolio for 2019‑20 was 2.95 per cent
(2018‑19: 3.26 per cent). This is an expected outcome and is below the 10 year average of the 10 year bond rate of 3.09 per cent.

The trajectory and level of financing costs are important considerations for the AOFM. In an environment of declining interest rates (which characterises most of the period since the GFC), the financing cost of the long term debt portfolio will, all other things equal, decline as the AOFM issues new debt at lower rates. The maturity profile of the portfolio is also relevant. The financing cost of the long term debt portfolio will also fall as debt issued in prior years when rates were higher matures and is repaid. The AOFM monitors the cost of the debt portfolio against the 10 year average of the 10‑year bond rate because this is a globally relevant benchmark indicator. It is also closely associated with AOFM’s aim of supporting the 10‑year futures contract and it represents a highly liquid part of the AGS market.

Indicator 2.2

Financing cost (issuance): The cost of Treasury Bond issuance over the past 12 months compared to the average 10‑year bond rate over the same period

Target

Lower

Result

Target met

The average yield of Treasury Bond issuance (accounting for the bulk of long term issuance) for 2019‑20 was 0.81 per cent (2018‑19: 2.29 per cent). This compares to the 2019‑20 average of the 10 year bond rate of 1.04 per cent (2018‑19: 2.26 per cent). The AOFM monitors issuance cost outcomes against the 10‑year bond rate because it is a market relevant benchmark indicator and represents a highly liquid part of the AGS yield curve (making it a useful cost indicator of market conditions for the year overall). The 12 basis point outcome deviation from the indicator is just outside the AOFM’s expectation of a range of around plus/minus 10 basis points.

The average term of new issuance in 2019‑20 was 8.75 years, which was shorter than planned issuance of 11 years average term to maturity (2018‑19 actual: 11.27 years).

The average yield on Treasury Bonds issued during 2019‑20 was lower than the average 10 year bond rate during the year. This outcome reflected the shorter average tenor of issuance of 8.75 years (compared with the 10 year cost performance indicator) and the ‘back‑loading’ of the issuance program in the second half of the year in response to the coronavirus and what was a significant rally in bond yields through the second half of the year. The AOFM also faced a period of severe market dislocation in March, which prevented any meaningful issuance of bonds. Once financial markets globally began to recover, most sovereign issuers were constrained to issuing only short‑term maturities as there was widespread investor aversion to taking on the interest rate risk associated with buying long‑dated maturities. The combination of market conditions and unforeseen materially higher issuance requirement made the AOFM’s planned target of 11 years average‑term‑to‑maturity of issuance unachievable.

Indicator 3

New issuance yields: Weighted average issue yield at Treasury Bond and Treasury Indexed Bond tenders less prevailing secondary mid‑market yields

Target

Issuance yields at or below the secondary mid‑market rate

Result

Target met

Average tender yields were below secondary mid‑market yields for both Treasury Bonds (0.32 basis points) and Treasury Indexed Bonds (1.01 basis points). This compares to 0.23 basis points and 1.37 basis points respectively in 2018‑19. In 2019‑20, the AOFM held 79 Treasury Bond tenders with a combined face value of $94.2 billion and 14 Treasury Indexed Bond tenders with a combined face value of $1.65 billion. This compares to 62 Treasury Bond tenders (for $51.4 billion) and 15 Treasury Indexed Bond tenders in 2018‑19 (for $2.15 billion).

How AOFM achieves this objective

The financing task is achieved through issuance of AGS, the mix of which is usually pre‑determined through an annual issuance strategy that balances debt portfolio risks (such as future interest rate volatility and funding risks) against differences in short and long‑term borrowing costs. Flexibility within the strategy is also important. The volume and mix of AGS issuance to achieve the financing task can be adjusted in response to changing circumstances (such as unforeseen changes in funding requirements). Such was the case in 2019‑20 where the AOFM faced (from March 2020 onwards) a material increase in the Government’s financing requirements during a period of considerable stress in the AGS market. The AOFM responded by increasing the volume and frequency of Treasury Bond tenders (with more reliance on shorter maturity bonds), launching two large Treasury Bond syndicate issues and upscaling short term Treasury Note issuance.

The method of issuance is determined by balancing considerations of supporting AGS market liquidity and managing execution risk against the anticipated transaction costs associated with different issuance approaches. The majority of issuance occurs via competitive tender, which achieves the ‘best cost’ outcome for the government in most circumstances. The syndication method is reserved for situations in which execution risk (due to large issuance volume or extension of the yield curve) and/or the trading liquidity of the security being issued are of primary consideration.

Of the $129.9 billion in gross term issuance for the year, $94.2 billion was issued via competitive tender, with new issuance yields consistently lower than secondary market yields. The remainder was issued via syndication. Financing costs on the overall portfolio also compared favourably against market indicator rates. More detail on each of these aspects is provided in Section 2 below.

Objective 2: Facilitate the government’s cash outlay requirements as and when they fall due

Indicator 4

Use of overdraft facility: Number of instances the RBA overdraft facility was utilised to the extent that it required Ministerial approval during the assessment period

Target

Zero

Result

Target met

There were two occasions in 2019‑20 where the overdraft facility was utilised. On both occasions the overdraft drawing amount was below the limit of $1 billion and did not require Ministerial approval. The use of the RBA overdraft facility was consistent with its purpose for covering infrequent, unexpected shortfalls in the overnight cash balance in the OPA group of accounts (even though more than sufficient assets will be held in term deposits with the RBA).

How AOFM achieves this objective

This objective is achieved through management of the cash portfolio with the AOFM forecasting daily revenue collections and expenditure. At times there are significant mismatches between expenditure needs and revenue collected, which the AOFM accommodates through managing cash reserves by placing term deposits and the use of short‑term borrowing. The AOFM aims to keep cash in the OPA sufficiently only to cover forecast outlays (plus a margin of error) while placing remaining cash as interest earning assets in term deposits with the RBA.

Objective 3: AOFM is a credible custodian of the AGS market and other portfolio responsibilities

Indicator 5

A liquid and efficient secondary market: Annual turnover in the secondary market for Treasury Bonds and Treasury Indexed Bonds

Target

Greater than previous year

Result

Target met for Treasury Bonds; not met for Treasury Indexed Bonds

AGS liquidity remained strong in 2019‑20. Turnover of Treasury Bonds totalled $1.5 trillion (a 19 per cent increase from the previous year). Annual Treasury Indexed Bond turnover decreased by 7 per cent, to $49 billion. There were no new Treasury Indexed Bond lines established in 2019‑20, and there was significant market disruption in this market in the March and June quarters also. Strong secondary market liquidity is a reflection of a range of factors but importantly includes regular AGS issuance by the AOFM that, amongst other factors, takes account of prevailing market conditions. The AOFM also plans issuance with the aim of supporting the futures contracts, promoting active market making by intermediaries, and supporting diversity of the AGS investor base.

Indicator 6

Market commitments: Number of times the AOFM failed to take actions consistent with public announcements

Target

Zero

Result

Target met

The AOFM’s actions were consistent with its public announcements throughout the year.

The Government’s response to the coronavirus unusually led to the AOFM revising and updating guidance multiple times over the final four months of the fiscal year. This included announcements on 12 March 2020, 3 April 2020 and 22 May 2020, which progressively updated the AOFM’s AGS issuance intentions including plans for new lines and weekly issuance rates. The AOFM’s actions were always consistent with the most recent public guidance in place. The regular changes to public guidance was driven by the evolving nature of the Government’s coronavirus response package and the fact that the measures were announced in stages. The AOFM considers operational flexibility to be an important enabler of achieving its market custodianship aims. This was reflected by the AOFM suspending issuance through mid‑late March when the Treasury Bond market was at its most stressed, and periodically revising issuance guidance.

The AOFM considers the above actions were consistent with public announcements but notes that revisions were necessarily made multiple times over the latter part of the year (a departure from the preferred and traditional approach of only updating guidance at the time of official Budget updates).

How AOFM achieves this objective

That the AOFM is judged by financial markets to be a credible custodian of the AGS market can be assessed from a number of perspectives. However, it is important to note that the AOFM does not have any regulatory or statutory authority and any influence it has in the market is only by virtue of its guidance and issuance operations (although it recognises the potential for this influence to be significant at times).

Good market liquidity is a key consideration for most investors because it reflects an ability to transact in the market (either through buying or selling AGS) in a timely manner and in volumes to meet their needs, without market prices being materially moved as a result of those transactions. Liquidity is a product of a number of factors, including having a wide range of active ‘price makers’ in AGS, regular issuance, and a large, diverse (and active) investor base. The AOFM supports liquidity through: restricting the number of individual bond lines so that each can have greater volume outstanding; regular and consistent issuance into maturities that are chosen to reflect investor demand; clear communication and transparency regarding the AOFM’s operations and issuance strategy; and a long‑standing focus on the development of a functional and resilient AGS market.

High levels of secondary market turnover and regular feedback from investors attesting to their capacity to buy and sell large parcels of AGS at acceptable prices are strong indicators of liquidity for 2019‑20. When the bond market was stressed in March and early April, the AOFM was forced to notably change its planned issuance activities to relieve pressure on the bond market. This was done by suspending issuance initially and then cautiously resuming with a focus on low risk (generally shorter term to maturity) lines and increased financing through Treasury Notes. This approach also reflected favourably on the AOFM’s credibility as a sovereign issuer and custodian of the AGS market.