Reference Committee
Discussion Paper
Making Submissions
Public Submissions
Media Releases and Speeches
Web Links
Contact the Review

Review of the

Commonwealth Government

Securities Market

Discussion Paper

October 2002

© Commonwealth of Australia 2002

ISBN 0 642 741662

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth available from the Department of Communications, Information Technology and the Arts. Requests and inquiries concerning reproduction and rights should be addressed to:

The Commonwealth Copyright Administration
Intellectual Property Branch
Department of Communications, Information Technology and the Arts
GPO Box 2154

Or posted at:

Printed by Canprint Communications Pty Ltd


Australian Treasurer Peter Costello
Australian Crest



Telephone: (02) 6277 7340
Facsimile: (02) 6273 3420


The success of the Government's fiscal strategy over recent years has reduced Commonwealth general government net debt as a proportion of GDP from almost 20 per cent in 1995-96 to 5 per cent in 2001-02. The fiscal strategy contributes to the current low interest rate environment, a key factor underpinning Australia's recent economic strength.

While the Government's fiscal record has delivered positive economic results, it also has generated concerns from some financial market participants and commentators about the future viability of the Commonwealth Government Securities (CGS) market.

The Government acknowledged these concerns in the 2002-03 Budget and committed to take stakeholders' views into account in considering the issue. This paper sets out a range of issues, to stimulate contributions from interested stakeholders so that they can form part of the Government's decision making process. The paper covers the range of possible roles that the CGS market can play and possible private sector alternatives, and assesses the measures the Government would have to implement to maintain the market.

I hope this paper will foster a broad ranging discussion of the future of the CGS market, and encourage all interested parties to put forward their views in a written submission.

Peter Costello's signature



Table of contents

Foreword iii

Executive summary 1

Introduction 1

Issues 1

The role of the Commonwealth Government Securities market 2

Appropriate size of the Commonwealth Government Securities market 6

Options available to the Commonwealth 7

Conclusion 9

Chapter 1: Introduction 11

Chapter 2: Overview of Australian financial markets 15

Australia's financial markets 15

Australia's debt markets 15

Commonwealth Government Securities 16

State and Territory government bonds 21

Corporate bonds 22

Debt issuance trends 23

Associated market infrastructure 25

Derivative markets 25

Clearing and settlement systems 28

Regulatory frameworks 29

Chapter 3: Role of the Commonwealth Government Securities market 31

Background 31

Minimal credit risk 31

High levels of liquidity 32

Broad range of maturities 32

Well developed market infrastructure 33

Pricing other financial products 35

Proposition 35

Key issues 35

Possible alternatives 36

Referencing other financial products 41

Proposition 41

Key issues 41

Possible alternatives 41

Managing financial risk 43

Proposition 43

Key issues 43

Possible alternatives 46

Providing a long-term investment vehicle 50

Proposition 50

Key issues 50

Possible alternatives 52

Implementing monetary policy 54

Proposition 54

Key issues 54

Possible alternatives 56

Providing a safe haven in times of financial instability 57

Proposition 57

Key issues 57

Possible alternatives 60

Attracting foreign capital inflow 63

Proposition 63

Key issues 63

Possible alternatives 65

Promoting Australia as a global financial centre 66

Proposition 66

Key issues 66

Possible alternatives 68

Chapter 4: Appropriate size of the Commonwealth Government Securities market 69

Commonwealth Government Securities as a benchmark for pricing other debt securities and managing financial risk 69

Commonwealth Government Securities as a long-term investment vehicle and safe haven 71

Risk premium considerations 73

Chapter 5: Options available to the Commonwealth 75

Introduction 75

Option 1: Wind down the Commonwealth Government Securities market 77

Description 77

Risk and return issues 77

Economic impact 79

Governance issues 80

Budget impacts 80

Transition issues 81

Option 2: Consolidate Commonwealth and State government debt markets 83

Description 83

Risk and return issues 83

Economic impact 84

Governance issues 84

Budget impacts 85

Transition issues 86

Option 3: Maintain the Commonwealth Government Securities market and fund the Commonwealth's unfunded superannuation liabilities 87

Description 87

Risk and return issues 89

Economic impact 94

Governance issues 97

Budget impacts 101

Transition issues 104

Appendix 1: Summary of key questions 105

Appendix 2: Description of risks in debt and asset management 109

Appendix 3: Macroeconomic implications 111

Economic framework 111

The demand for Commonwealth Government Securities 113

The supply of Commonwealth Government Securities 115

Supply and demand of alternative investments 115

Determination of domestic output and the current account 115

Implications of a diminishing Commonwealth Government Securities market 117

Global bond index argument 121

Extreme illiquidity in the Commonwealth Government Securities market 122

Implications of maintaining the Commonwealth Government Securities market 123

Government investment in domestic assets 124

Government investment in foreign assets 125

Longer-term stability issues 128

Conclusion 131

Appendix 4: Selected international experience 133

Government debt markets 133

Singapore 133

Hong Kong 135

United States 137

Republic of Korea 140

Managing Government asset portfolios 142

New Zealand 142

Norway 145

Canada 147

Ireland 149

Appendix 5: Decision on consolidating Commonwealth and State debt markets 151

Bibliography 153

List of tables

Table 1: Commonwealth Government Securities outstanding 17

Table 2: Correlation of changes in interest rate swap rate with other debt security yields 47

Table 3: Holdings of Commonwealth Government Securities by sector 51

List of charts

Chart 1: Commonwealth general government net debt 11

Chart 2: Fixed coupon bonds outstanding by issuer type (June 2002) 16

Chart 3: Benchmark Treasury Fixed Coupon Bonds outstanding (June 2002) 18

Chart 4: Treasury Indexed Bonds outstanding (June 2002) 19

Chart 5: Net short-term assets and Treasury Notes outstanding in 2001 20

Chart 6: State and Territory bonds outstanding (June 2002) 21

Chart 7: Corporate bonds outstanding by issuer 22

Chart 8: Maturity profile of corporate fixed coupon bonds outstanding (June 2002) 23

Chart 9: History of outstanding bonds 24

Chart 10: Turnover in Australian fixed coupon debt markets 25

Chart 11: Turnover of Treasury bonds and Treasury bond futures contracts 26

Chart 12: Turnover of Treasury bonds and interest rate swaps 27

Chart 13: Turnover in the repurchase market by instrument 28

Chart 14: Commonwealth Government Securities yield curve (June 2002) 33

Chart 15: Outstandings and turnover in the Australian corporate debt market 37

Chart 16: The interest rate swap curve (June 2002) 38

Chart 17: Spread of corporate bonds to Treasury bonds 58

Chart 18: US corporate-government bond spread and Dow Jones Index 59

Chart 19: Australia's current account balance 63

Chart 20: Commonwealth Government Securities outstanding if retired at maturity and no further issuance 70

Chart 21: Growing the Commonwealth Government Securities market in line with nominal growth in gross domestic product 71

Chart 22: Growing the Commonwealth Government Securities market in line with growth in financial assets 72

Chart 23: Australian financial asset market size (June 2002) 91

Chart 24: Size of Government investment possible with investment limits 92

Chart 25: Demand for CGS 114

Chart 26: IS-AMP-BP Framework 117

Chart 27: Reduced supply of CGS 118

Chart 28: Effect of reduced CGS supply in the IS-AMP-BP model 120

Chart 29: CGS demand with global bond index investors 122

Chart 30: Extreme illiquidity and reduced CGS supply 123

Chart 31: Investment of budget surpluses in domestic financial assets 124

Chart 32: Increased CGS supply and foreign investment of proceeds 126

Chart 33: Effect of increased CGS supply in the IS-AMP-BP model when government invests in foreign assets 127

Chart 34: Ongoing budget surpluses 129

Chart 35: Ongoing budget deficits 130

Chart 36: Singapore Government securities on issue 133

Chart 37: Hong Kong Government securities on issue 135

Chart 38: US government, corporate and agency securities on issue 138

Chart 39: Korean government and corporate securities on issue 140

Chart 40: New Zealand Government asset portfolios: 2002 to 2006 142

Chart 41: Accumulated assets in the Government Petroleum Fund 145

Chart 42: Canadian Pension Plan asset holdings 147

Chart 43: Accumulated assets in National Pensions Reserve Fund 149