Super-long and Perpetual Gilts

Transcription

1 Super-long and Perpetual Gilts The ABI s Response to the DMO s consultation document Introduction 1. This is the response of the Association of British Insurers (ABI) to the Debt Management Office s consultation on the feasibility of issuance of super-long and of perpetual gilt-edged stocks. 2. The ABI represents the UK s insurance, investment and long-term savings industry, the largest in Europe and the third largest in the world. It has over 300 members, accounting for some 90% of premiums in the UK domestic market and who undertake the management of investments of some 1.5 trillion. General comments 3. We are pleased to respond to this consultation on elongation of the maturity spectrum for gilt issuance. The introduction of super-long gilts, defined as maturities beyond 50 years, has the potential to meet the interests of both supply and demand sides. For the UK Government there is a need to finance an increasing and likely pervasive borrowing requirement where the opportunity to lock in what are low nominal and real interest costs relative to historic experience and in relative terms to other jurisdictions with similarly high prevailing public sector borrowing requirements, must be attractive. It would also help give improved market signals to those responsible for the conduct of overall macro-economic policy. 4. For investors the ability to access assets deemed by regulators to provide risk-free matches for the substantial quantity of long duration liabilities that insurers and pension funds are exposed to, would be attractive. The existence of such assets would also be likely to help improve the health of the overall market for fixed-interest assets of all types at long maturities. 5. Accordingly we welcome the prospect of introduction of super-long gilts and believe that the UK authorities should in point of principle accept a commitment to seek to develop a flourishing market in such instruments. In the current low yield environment, however, the substantial potential demand is less likely to become immediately converted into actual demand. It would therefore be right, given current market circumstances, to view this as a medium to long term project and not expect to take what would be seen as an unduly opportunistic approach in the current market environment where yields are low generally but specifically so for high quality and risk-free fixed interest instruments. We suggest in our response that the most productive way forward might be to proceed incrementally in a way that will develop over time the scope of the existing ultra-long segment of the market by adding maturities beyond the current 50-year boundary. The preference of some

2 investors would be for a perpetual gilt but it is clear that the choice of that route would need a change to the current design which incorporates a repayment option for the Government and negates the value of such instruments for those seeking to match liabilities and meet regulatory requirements. 6. In catering to the overall spectrum of requirements of gilts investors, super-long issuance is just one avenue for providing assets which give a closer match for liabilities and achieving efficient financing for the UK Government. Another would be to recognise the significant quantity of limited price indexation (LPI) pensionrelated liabilities to which insurers and pension funds are exposed. We would welcome further thought being given by the DMO to the feasibility of issuance of gilts that would match these liabilities. 7. We would be happy to assist the DMO further over any of the matters we comment on in our response, or otherwise that would be helpful to the DMO in carrying forward this project. 2

3 Questions for Consultation ANNEX A. Market demand for super-long or perpetual issuance 1. What are the potential sources and scale of demand (both new and existing) for super-long and perpetual gilts? We believe there is a range of investors with potential interest in investing such securities. These include (but not exclusively so) institutional investors, that are responsible for investing to match very long-dated pension annuity and, to a lesser extent, other insurance-related risks. Depending on future regulatory developments, including the possibility that elements of Solvency 2 will be incorporated into the IORP directive covering pension funds, it is likely that there will be interest from this constituency also. 2. To what extent would demand for super-long and perpetual gilts translate into more cost-effective financing for the Government relative to existing instruments? There is a high probability that UK Government borrowings maturing in 50 years will need to be refinanced at interest rates materially higher than those prevailing at the present time. This reflects current conditions in the gilts market as to prevailing interest rates (very low by historic standards at least in an environment of fiat money, in real terms in the case of index-linked debt and, in respect of conventional debt, at very modest yield premia to the Bank of England s Monetary Policy Committee s inflation target). It is unlikely that the current environment will prevail indefinitely although demand dynamics arising from solvency matching we think are likely to be pervasive. It is not therefore possible to conclude that super-long issuance will always offer the same prospect for highly attractive long-term funding costs for Government. Issuance in the present environment would therefore enable Government to lock in what are highly likely to prove attractive funding costs. 3. How would issuance price relative to existing ultra-long gilts? We do not see any obvious basis for concluding that super-long gilts would not price similarly to ultra-longs. 4. To what extent would issuance of super-long and/or perpetual gilts displace demand for existing ultra-long gilts? This would be the case to a significant extent but potential demand is already large relative to supply and, accordingly, we do not think limited demand would be an argument not to extend the maturity spectrum. 5. How sustainable would demand be for super-long and perpetual gilts? 3

4 This will primarily depend on future liability patterns, but also on any changes to regulatory requirements. If prevailing interest rates were in future to rise we would expect to see an increase in demand from those investors with long-dated liabilities to match who are currently reluctant to lock in low investment returns for the longterm 6. If the longest maturity at which the Government issues conventional and index-linked gilts was to be extended, at which new maturities would there be most potential demand for issuance? The greatest demand would be at maturities adjacent to the existing 50-year cut-off. B. Supply of new instruments 7. How should the Government seek to integrate issuance of super-long and/or perpetual gilts within its existing issuance programme? We think, given also experience with development of ultra-longs, that the optimum approach would be a simple extension of the range of maturities of existing ultralong benchmarks. 8. If the Government proceeds with issuance of super-long gilts, how much should it seek to supply per financial year? We have no specific target to suggest in the nearer term and suggest that if the Government takes this forward it might be best to extend incrementally the existing ultra-long maturity spectrum and issuance programme. 9. Should the yield curve be extended gradually through issuance of superlong gilts, or are there specific maturities at which issuance should be directed? We think that if the maturity band is extended it should be done incrementally beyond the current 50 year cut-off. We see no obvious demand for maturities such as the previously mooted 100 years where we expect very little liability-related demand would exist. Although liability patterns extending to, say 80 years, have been suggested, the quantum of such liabilities is likely to be very low and unlikely to support deep and liquid issues of gilts. 10. If the Government proceeds with issuance of perpetual gilts, how much should it seek to issue and over what period of time? Although we see some definite attraction in the concept of perpetual gilt issuance which could provide a suitably concentrated supply of duration, we see no merit in issuance of perpetual gilts of similar design to existing undated stocks. The currently available instruments have no natural attractiveness to institutional investors seeking to assets to closely match their liabilities. 11. What would be the appropriate method(s) of issuance of super-long and perpetual gilts? We think these would be similar to, or identical to, those for ultra-long gilts. 4

5 C. Risks of issuance 12. To what extent would issuance of super-long and/or perpetual gilts risk fragmenting long-dated or index-linked gilt supply or liquidity? What steps, if any, could the Government take to minimise this risk? There is some risk of this but it ought to be manageable. With carefully chosen number of benchmark issues we think the benefits outweigh the disadvantages. 13. Are there any other issues and risks that the Government should be aware of in launching super-long or perpetual gilts? If so, how might any such risks be managed and what is their relative importance in determining which (if any) instruments to issue? We have no specific suggestions to make. D. Instrument design 14. Are there any changes that should be made to the design of conventional or index-linked super-long gilts relative to existing instruments? Current perpetual issues constitute, as the consultation document correctly identifies, a very small proportion of outstanding gilts. Changes to terms that would be useful to gilt market users could be made at nugatory cost to Government. We suggest that the Government could convert its repayment option over existing undated gilts into a facility for the Government at its discretion to make an offer to holders to be redeemed at the holder s option, or an economically equivalent redemption and reinvestment option into a new perpetual gilt of equivalent coupon. This would significantly increase the attractiveness of undated gilts to institutional investors seeking long-duration stocks to match very long-lived liabilities. 15. If the Government were to issue new perpetual gilts, how should they be structured? What key features should be included in their design? What features should be avoided? We think that to incorporate a first redemption date to be exercised at the discretion of the Government will negate the value of this type of instrument for institutional investors, require significantly higher coupons and provide less effective cost of funding for the Government. The Government perhaps wishes to retain a repayment option against the possibility (which we recognise cannot be zero) that at some future date there is no longer a need to maintain a UK Government debt market and the issue is therefore surplus to funding needs. In this case the repayment option enjoyed by the Government should be designed on a basis designed to permit holders to exit without facing material reinvestment risk and hopefully to gain modest compensation for disturbance. E. Lead time required prior to issuance 16. What would be the lead time required by Gilt-edged Market Makers (GEMMs) and investors before issuance of either super-long or perpetual gilts could take place? 5

6 We have no specific view to provide. F. Market maker responsibilities 17. If the DMO were to issue either super-long or perpetual gilts, should the roles and responsibilities of the GEMMs be identical to those for existing gilts? We have no view that such roles and responsibilities need to be different than those currently applicable. G. Gilt market management 18. What should be the implications, if any, for existing undated gilts should the Government decide to launch a new perpetual gilt? If it is found that significant demand exists for a new type of perpetual gilt and that a thriving market can be established there would be obvious merit in converting existing gilts to accord with the modernised terms of the new issues. ABI 14/8/12 [s:\inv\consultations\other domestic\2012\dmosl&pgmy12 6