TRANSCRIPT: Interview with AOFM’s Robert Nicholl on 4 May 2021

5 May 2021

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on May 4 with Australian Office of Financial Management CEO Robert Nicholl:

Q: What can you say about possible further efforts to extend the maturity of your curve?


A: We have been considering this on and off now for quite a few years (while we were originally extending the yield curve to 2047), but we are pretty confident that there is not nearly the sort of depth and volume of demand for, say, 50-year maturities in AUD that there is in the core currency markets, i.e. US dollar and euro.  There is no portfolio benefit to us in having a small amount at 50 years and there is by no means any indication it would be a liquid part of our market. It’s a lot of risk for intermediaries to warehouse and this means it would be very challenging to tap such a line by tender after it was established. In any case, now would definitely not be the time to try given how steep our yield curve is.


Q: With so much new government borrowing necessary to mitigate the fallout from the pandemic, how do you expect to handle this operationally?


A: The last official budget update indicates 2020-21 to be the highest issuance year (i.e. the current year that concludes on 30 June), and we have issued just under $200 billion of an announced $230 billion program. The forecasts indicate quite a drop into next year and the out-years, so it looks like the worst is behind us. That said, we have a lot of operational flexibility in terms of issuance options in the bond market, healthy access to cash markets through our Treasury Note issuance, good liquidity, broad intermediary support and well-honed issuance methods, so I feel we are adequately prepared for ongoing large issuance tasks or the emergence of further market shocks/volatility.


Q: As issuer, how do you see the country’s balance sheet position?


A: The government has a relatively strong balance sheet position even after the impacts of last year. The constant feedback we get from investors is that the market is very liquid and they understand the AOFM as an issuer – together I think this is only positive for Australia.


Q: Are you concerned as debt issuer by rising tensions between Australia and China? Are there any scenarios you need to prepare for? In particular, could there be an impact on Australia’s sovereign rating?


A: We don’t at this stage hold any specific concerns as an issuer.


Q: Is it still the case for the foreseeable future that the TIB program would not make a meaningful contribution to the government’s financing task?


A: Yes, I think that is reasonable to assume. Most linker markets are relatively small compared to nominal programs and this is no different for Australia. The market relies heavily on domestic investors and we have not seen the fund manager mandates change (i.e. increase) that much over the years. We are mindful of not pushing issuance too hard into this market, but of course have considerable flexibility to respond to underlying shifts in demand should they emerge. Who knows what lies ahead, though – we are in a world of much uncertainty as to the potential for a breakout in CPI. We have certainly seen a lot of asset price inflation since the GFC, but views are evenly divided, it would seem, on whether the prices of goods and services are set to take off appreciably.


Q: Your curve goes out to 2051, which you just syndicated. How do you feel about the results of that?


A: This was considered a very successful transaction. It was around twice the print size of our first 30-year benchmark (the 2047) and at a yield less than 2%. It again highlighted the significance of this part of the curve, given it attracted the highest number of individual investors of any deal we have done across the curve. It was also conducted not too long after markets had experienced the greatest volatility since the GFC – and if we think back to that time, there was still a lot of uncertainty as to underlying budget positions and the outlook for the coming 6-12 months.


Q: To what extent was the issue of the 30-year to satisfy superannuations?


A: This was not a specific motivation, although we would have been confident that superannuation funds would find their way into the deal. When we did the 2050 linker, that was definitely a new bond establishment that had a keen eye to specific domestic superannuation demand (and we had certainly taken a lot of feedback to that effect ahead of deciding to do it and by choosing the actual maturity). The central motivation for the recent deal was to maintain the 30-year nominal yield curve and in that way keep faith with the guidance we had been giving to the market.


Q: How satisfied are you about your mix of syndication and tender?


A: We typically rely on regular weekly tenders for most issuance and in the past this has included establishing new bond lines to support the 3-year futures contract when required. Syndications are usually the means by which we establish new long bond maturities because they allow for good volume (to boost initial liquidity of a new line) while reducing execution risk.  Last year we relied heavily on syndications because we needed high volume issuance at a rate we had never experienced before.  The two approaches (tenders and syndications) complemented each other very well in our mind and of course the prospect of syndications is an additional motivation for intermediaries to be active price-makers. If you compare what we did in 2020 to most of the main OECD countries, a heavier than usual reliance on syndications was a common approach. We have also over the last 4 year used smaller syndications to tap existing ultra-long maturities while building outstanding issuance in that part of the curve.


Q: What sort of innovation might we see from the AOFM going forward?


A: I don’t really see us as an “innovator” as such although we are regularly reviewing our approaches to all facets of our operations.  We are often looking to modify our approaches on the basis of relevant experience (learning) and changing circumstances. When we are about to make changes that we think the market needs to understand we communicate the specifics (and reasoning) through a speech opportunity or regular guidance.


Q: How do you see the future of green issuance in Australia?


A: We are not planning to enter the green bond market at this stage. It would be a policy decision by government to want to initiate that and unless we could get a very large volume away at markedly lower yields I don’t see the benefit for the taxpayer in us issuing green bonds. However, we are following all ESG related market developments closely (and especially through the OECD forum) and I will be interested to see how the concept of ESG issuer ratings, as opposed to specific instrument ratings, unfolds overtime. This has the potential to limit the relevance of green bonds as the market develops so I will be curious to see where this heads.

Q: Regarding long-dated issuance and its importance from the standpoint of helping the futures market flourish, the latter is still somewhat underdeveloped despite recent efforts. Open interest in LTY remains very low; does the AOFM bear this in mind when issuing?

A: I take it you are referring here to the Australian Securities Exchange’s 20-year futures contract. It lacks liquidity compared to the 3- and 10-year contracts in particular, and I think there are several reasons for this. We tend to find that on average, a lot of ultra-long bonds (15 years plus) are held for long periods – almost on a buy-and-hold basis. This I think reflects considerable fund manager interest for liability matching purposes, and therefore the re-positioning and trading in these bonds is at a much lower level than bonds shorter along the curve that are traded for a wider range of reasons.  Many (but not all) of these bonds tend to be held on an outright basis, as we understand. We have done everything we think we can as an issuer to support the 20-year futures contract, but ultimately its use comes down to market preferences.  What we have done is establish the 2035, 2037, 2039 and 2041 maturities specifically to support the contract, plus we have referenced it (as opposed to actually pricing of it) in a few of those syndications. Over time, our 30-year benchmark bonds will roll down the curve to support the contract and we will continue to look for opportunities to tap existing lines. When it comes down to it, though, I don’t think we as the issuer have any more control over its success than we have tried to promote to date.

Q: Regarding the degree to which RBA QE is reducing liquidity in the secondary market, at what point will this become excessive from your standpoint? This is especially true of the April 2024 bond, which is 60% owned by the RBA despite being a constituent of the 3-year bond futures basket.

A: It is not clear at this stage that the RBA’s operations are having a noticeable impact on secondary market liquidity generally, although as you point out there are certain bond lines that would be extremely tight. The April 2024 is obviously a line that has been targeted heavily by the RBA because of its YCC target. We are not aware of any dysfunction that would cause us as the issuer any specific concern, although we are aware that liquidity of the ASX’s 3-year futures contract has been impacted by the YCC operations. Depending on whether the RBA decides to extend its YCC target beyond the April 2024, we expect this tightness to dissipate over time.

Q: Would you be comfortable if the RBA ended up owning 50% of the whole market, much like the BoJ in JGBs? RBA ownership is currently around 22% but this could rise to around 35%-38% by the time QE ends.

A: I think we are a long way from that scenario to be honest, and in any case we are not treating the RBA’s QE purchases as a constraint on where we issue, so if we start to see market reaction to tightness in bond lines further out along the curve from the YCC target, we can (and have) responded to that with new issuance. But it is really market conditions giving rise to these indicators in my view, rather than the RBA’s operations per se, because there can be quite a lag between RBA purchases and then suggestions to us that we issue particular line that may look to be tight. And we might not even be asked to issue into some of these lines – the bond lines between the 3- and 10-year futures contracts have typically constituted a relatively “dormant” part of our market from year to year.