The scale of the first one — the DMO saw its budget remit hit £220bn in 2009-10 — was surely never going to be beaten. But along came the coronavirus and the DMO saw its funding requirement top out at £485.5bn in 2020/21 which has resulted in a budget remit for this year of £295.5bn.
Of course the UK is far from the only sovereign in seeing its funding requirement blow out — and like in other leading advanced economies, the central bank has waded in with a much increased quantitative easing programme. But after Brexit, the UK is more alone than ever and this is an extra complication that investors have had to confront.
Meanwhile, this financial year should see the UK make its entry into the sovereign green bond market, although much of the detail and underlying issuance framework has yet to be finalised.
GlobalCapital's editor Ralph Sinclair spoke to Sir Robert earlier this week about how the DMO will use its now deep experience of crises to tackle what is one of the largest funding remits in its history against a highly uncertain economic backdrop — one that includes the potential stirring of inflation, the impact of the vaccine rollout, the uncertainty over the role of QE and the yet-to-be-seen true implications of Brexit.
GlobalCapital: In the 2020/21 fiscal year, the Gilt remit rose by £329.4bn to £485.5bn. Meanwhile, the Bank of England between March 2020 and now has done £430bn of quantitative easing in the Gilt market, meaning it has bought more than 93% of that year’s remit. How did investors react to that? Were they delighted to see Gilt prices so well supported, or are they worried about ever dwindling yields?
Sir Robert Stheeman, DMO: Some investors inevitably worry about dwindling yields. Investors want to receive the highest yields possible and issuers want to pay the lowest but the market price is, in a sense, what we both end up paying — we accept what the market extracts from us and vice versa.
I am not sure whether the Bank of England, through its Asset Purchase Facility, is the ultimate decider of price. It obviously has an influence but the market valued the presence of the Bank not from a yield perspective but as a sign that it was assisting market stability during an extraordinary period. All parties valued that.
Are there any indications as to how much the Bank will be taking of the 2021/22 remit of £295.5bn, or how investors feel about that?
I have no doubt investors will form their own opinions of the APF, quantitative easing and many other things, including the growth prospects for the economy.
That all feeds into one defining factor in the Gilt market. Over the last 12 months — and for much longer before that — the biggest determinant of Gilt yields was not what the central bank was doing in the market on any given day, it is what the market expects the future path of interest rates and monetary policy to be. That has held since time immemorial.
Quantitative easing is just one aspect of an overall picture that is ultimately painted by market expectations of future interest rates.
How has the DMO had to alter its interaction with investors and the GEMMs since the pandemic began?
The substance of our consultations with investors has not changed, though the format has in that we have carried them out virtually.
On a personal level, I miss the interaction of a real in-person meeting with investors and with our primary dealers. We have done a couple of virtual roadshows for investors in different time zones but it is not quite the same as a real one.
I look forward to the time we can meet in person and have less formal and maybe less stilted conversations about the market. It is harder to interact like that in a virtual meeting. When people visit the DMO, I like to be able to offer them a coffee. I can’t do that at the moment.
That personal aspect is one thing a lot of people in the business in general miss.
You mentioned investor relations work with international Gilt buyers; what has been their behaviour in the market given they have not only had the pandemic to worry about but also the reality of Brexit?
They did have Brexit to worry about but as an event risk rather than as a matter of policy. What concerned them were the successive looming deadlines that dominated last year. We no longer have those to worry about now. But the Brexit negotiations in general had remarkably little effect on the Gilt market. The impact of Brexit was felt more in currency markets.
The relative strength of sterling since the end of December has been, I think, less about Brexit and looming deadlines and more about a focus on the growth potential of the economy resulting from a faster than expected vaccine rollout.
Rising yields in the Gilt market, like in the US Treasury market, are about growth prospects too. If you think the economy is growing, you might think interest rates will rise sooner rather than later.
Last week you announced a financing remit for the 2021/22 financial year of £295.5bn. It is the second highest annual total since 2009/10, with the highest being the last year’s remit which started at £156.1bn and ended up at £485.5bn. The task of issuing Gilts has clearly changed a great deal over the last year. How different has planning how to raise that money from the market in 2021/22 been compared to previous years?
For the 2021/22 remit we have the slight advantage of having had the experience of raising £485.5bn in 2020/21 and also knowing the scale of the task ahead of us.
The 2020/21 remit was extraordinary — a financing task of unprecedented size, which was constantly revised upwards to a varying extent, according to the path of the coronavirus pandemic.
Announcing partial in-year extensions to the remit is not how we like to deliver our financing programme in an ideal world. The market understood why it was hard for us to be completely predictable last year, but for 2021/22 we have been able to return to a normal full year remit. I believe the market appreciates that we are going back to programmatic issuance.
We had no choice but to completely revise our approach in 2020/21. Until then, we typically held an auction usually around 10.30 on an auction day, of which there could be up to three in a week, but that frequency was rare. The Post Option Auction Facility [PAOF] used to close at 2.00pm
As 2021-22 began it soon became clear there was no way we could raise what we needed to raise with the earlier approach, so we increased the POAF rate from 15% to 25% and often held two auctions in a day, with bids closing at 10.00am and 11.30am — and with associated PAOFs at 1.00pm and 2.30pm.
For 2021/22 we are maintaining these two features but we are trying to plan them with greater certainty.
The new remit is big by historical standards. It will not only be the second highest annual remit but also the largest announced at the start of a financial year.
But Gilt sales of that size also allow us to service the whole market, supplying Gilts across the yield curve and addressing all parts of the investor base.
The chancellor of the exchequer’s Budget speech last week contained a great deal for ESG enthusiasts, not least of which was further confirmation of the UK’s first green Gilts to be sold later this year. Can you update us on the progress the UK has made with its green bond framework?
The framework is due to be published by the end of June. As the chancellor also announced, we plan to issue at least £15bn in green Gilts in the 2021/22 financial year.
We plan to issue the inaugural green Gilt over the summer but it is important that investors digest the framework first so we will be cautious in being too specific now over the timing of the issuance — our ambition for the year as a whole, and beyond, is what is important.
We have made no decision on maturities yet. After the next quarterly consultations with GEMMs and investors in May, we will be in a better position to discuss that.
From a technical perspective we have £28bn of unallocated issuance which can be for any type of Gilt by any issuance method. This is bigger in size and as a proportion of the total remit than before, reflecting the fact that green Gilt issuance will be allocated from that pot.
That unallocated amount last financial year was £8bn. Can we conclude therefore that green Gilt sales will be £15bn-£20bn in 2021/22?
I cannot confirm the final size of green issuance at this stage, but the unallocated pot provides flexibility in this context.
Has the DMO been leading the effort to construct the green bond framework or has there been greater input from HM Treasury?
Legally speaking, the DMO is part of HM Treasury and there is an internal Treasury-DMO working group, which also works with our structuring advisors, HSBC and JP Morgan, to draw up the framework.
HM Treasury will be leading on the engagement with other government departments to identify areas of green spending. The chancellor has been in contact with his counterparts at the relevant departments to encourage them to help HM Treasury
The UK has not yet appointed a second party opinion provider but discussions are ongoing.
There have been various examples of sovereign green bonds already, from conventional defined use of proceeds bonds, to issues like Germany’s, which was designed to be fungible with a conventional Bund, and XXX Finland’s approach, which is to have strippable coupons. Which countries is the UK looking at when deciding how best to approach the product?
I’m not sure we are trying to emulate a particular issuer or jurisdiction. What we would like is to see is what has worked in the green bond market internationally and what hasn’t, and to pick the best aspects..
It is too early to comment on the structure of the green Gilt but we will study all formats carefully. A key priority is to build a liquid curve over time, but also we would like the first green Gilt to be deemed liquid as early as possible.
Sometimes there can be a cost to being the first issuer of something and it can pay to wait. First movers can find something has worked well but others may find their initial design may not prove to be the most enduring.
For example, in the modern era, the UK was the first major issuer of inflation-linked bonds, starting in 1981. The design of the inflation-linked Gilt market from 1981 to 2005 was to have an eight month inflation lag in terms of looking back to calculate inflation during the period.
But other issuers of index-linked debt brought out their own versions of the product which used a three month lag and over time, a three month lag became accepted as best practice and the market standard and the UK switched, with our first three month lag index-linked gilt, IL 2055, being issued in October 2005.
How important is the cost of funding to the UK with a green Gilt?
For me, green Gilts have to represent overall value for money. Cost of funding is a critical part of that judgement, but in considering value for money you have to make a wider judgement— value for money is not determined solely by the cost of funding.
I am reminded of the Oscar Wilde quotation that “a cynic is a man who knows the price of everything, and the value of nothing.”
We try not to be too cynical.
Have you decided whether green Gilts will be syndicated?
We have not decided at this stage. One factor to consider will be the maturity of the deal — we tend to prefer syndications for longer dated Gilts but we cannot give a definitive answer now on the format of the issuance mechanism.
Another feature of the Budget was the announcement of the UK Infrastructure Bank. Will the DMO be involved in raising funding for it?
At this stage I do not know exactly. It depends how it will be financed. When issuing debt it is usually better value for the government to fund itself through the Gilt market. It seems logical that the DMO might be involved unless the UK Infrastructure Bank can fund itself cheaply, or otherwise operates at greater arm’s length from the government.
With rates still low but possibly starting to rise for the longer term, will the DMO be conducting any asset-liability management to take advantage of where interest rates are?
We do not explicitly take that approach. We can conduct buy-backs for cash management purposes but not to change the maturity profile of the portfolio. We will also sometimes buy Gilts close to maturity for redemption management purposes if the market price is right.
The trouble with buy-backs can be that if you buy a lot, you can influence the price and they can become cost-ineffective.
