ANNUAL REPORT / AGENCE FRANCE TRÉSOR

Transcription

1 ANNUAL REPORT / AGENCE FRANCE TRÉSOR

2 Agence France Trésor Annual Report Publication Director: Bertrand de Mazières Publisher: Agence France Trésor Design and production: Agence France Trésor - Les Éditions Stratégiques +33(1) Printers: Caractère SA Photo-Credit: Photodisc, Digital Vision, Brand X Pictures, Eric Baret/Sunset AGENCE FRANCE TRÉSOR 139, rue de Bercy - Télédoc Paris Cedex 12 - France Tel: fax:

3 AGENCE FRANCE TRÉSOR / Annual report Contents _ contents page 04 / A message from the Chairman page 06 / Organization Chart - Profile - Key figures page 12 / Macroeconomic environment: Sustained world economic growth page 20 / Managing the debt: regularity, transparency and innovation page 36 / Active management of the State s cash position page 44 / Rigorous real-time risk management page 50 / New computer system page 54 / 2005 Financial review page 82 / Contacts

4 04 05 A message from the Chairman Ending reliance on government debt The year 2005 provided the government first and foremost with an opportunity to raise public awareness about the importance of curbing the growth of government debt. This was the goal that the Minister for the Economy, Finance and Industry, Thierry Breton, had in mind when he gave Michel Pébereau, the Chairman of the BNP Paribas Supervisory Board, the task of chairing a commission to study France s government debt. The Commission s report was released in December Entitled Ending reliance on government debt, it provides an accurate and uncompromising review of France s public finances. It maintains that our political and collective practices, such as our preference for public expenditure are the cause of the current financial situation. It sets out detailed proposals for straightening out public finances over five years, through better control and use of expenditure. After reviewing the report, the government put forward a multi-year public finance programme with the goal of bringing government debt back down to 60% of GDP by 2010, based on a conservative assumption of 2.25% annual GDP growth, or by 2009, based on a more ambitious assumption of 3% annual GDP growth. Xavier Musca Head of Treasury and Economic Policy Directorate Chairman of AFT Earlier, Senator Paul Girod, Special Rapporteur for the Senate Finance Committee, released a report entitled Consolidated management of State s debts in July This report highlights the multitude of bodies responsible for managing the State s other debts and estimates that the added cost of this arrangement is likely to run to several tens of millions of euros. In the light of this report, the 2006 Budget Act stipulates that the State shall take over, and that the AFT shall manage, some of the debts contracted by public establishments, such as EMC (Entreprise Minière et Chimique) and FFIPSA (Farmers Social Security Fund). Within the State itself, the AFT and the General Directorate of Civil Aviation arranged to end separate borrowing to finance the autonomous budget for civil aviation. On the economic front, 2005 featured historically low interest rates, especially at the long end of the yield curve, making financing terms exceptionally good. The average weighted yield on issues is 2.13% for short-term debt and 3.18% for medium- and long-term fixed-rate debt, as opposed to 2.04% and 3.7% in Two years of low interest rates stabilised the net budgetary cost of negotiable debt, despite the increase in the amount of debt outstanding. The interest paid out of the State budget increased from 38.3 billion in 2004 to only 38.9 billion in 2005, whereas the amount of medium- and long-term negotiable debt outstanding increased from 736 billion to 782 billion. As was the case in 2004, France continued to enjoy better interest-rate conditions, on a par with Germany s, despite the latter s historical advantage on financial markets. Non-residents attraction to French government securities grew even stronger, with a holding rate of 56%, as opposed to 49% in the previous year. This diversification is testimony to foreign investors confidence.

5 AGENCE FRANCE TRÉSOR / Annual report A message from the Chairman _ For Agence France Trésor, 2005 featured two red-letter dates: On 3 February 2005, a survey of French and foreign investors was launched to see if the time was right for the issue of a 50-year OAT bond. This was followed on 22 February, with the first syndicated issue of the 2055 OAT. This issue of an ultralong-dated bond was a first for a G7 country. The bond was a great success with subscriptions of nearly 20 billion far outstripping the 6 billion offered in the syndicated issue. With three further issues in the interim, the 2055 OAT continues to meet strong demand from investors all over the world. The weighted average yield obtained at issue in 2005 and 2006 is 4.1%. On 5 December 2005, it was announced that a secondary OAT market would be created for individual investors. The market for French government bonds is one of the most liquid in the euro market for institutional investors, but it is not very accessible for individual investors. Therefore, working in partnership with Euronext and the primary dealers, AFT decided to create a secondary market with real-time quotes to provide the liquidity and transparency that any investor is entitled to expect from an issuer. The secondary market was launched on 2 January 2006 with the backing of the major banks. These two very different operations enabled the AFT to continue its drive for innovation, based on the principle of meeting the expectations of institutional and individual investors in France and around the world. IMPROVING HEDGING OF THE STATE S FINANCIAL RISKS The AFT continued to expand its activities in 2005 by carrying out its first risk hedging transactions on behalf of other government agencies. This involved hedging the currency risk for France s contribution to the International Development Association managed by the World Bank and hedging the commodity price risk on behalf of the military fuel service. Starting in 2006, these transactions, along with other later transaction for micro-hedging purposes, will be centralised on a newly-created single trading account for hedging the State s financial risks to ensure transparent monitoring and supervision. Xavier Musca

6 06 07 Organization chart - organization chart Xavier Musca Head of Treasury and Economic Policy Directorate and Chairman of AFT Strategic Committee Bertrand de Mazières Chief Executive Benoît Cœuré Deputy Chief Executive Secretary general Information Technology Alain Mercy Jean-Pierre Cornillaut Jean-François Martini Cash Management Debt Management Back-office Middle-office Operational Research Macroeconomics Information Frédérick Jeske Baptiste Janiaud François Marion Françoise Blondeel Nicolas Sagnes Richard Brun Corinne Dromer [zoom] AGENCE FRANCE TRÉSOR STRATEGY COMMITTEE The Strategy Committee assists AFT in its management of the State s debt and advises it on the broad outlines of its issuance policy. The Committee also helps AFT implement debt management principles and procedures. As of 31 March 2006, the Strategy Committee members were: CHAIRMAN Jacques de LAROSIÈRE Former Governor of Banque de France and Adviser to the Chairman of BNP Paribas. MEMBERS Peter FISHER Former Chairman of the Federal Reserve Bank of New York, Managing Director of Blackrock Asia. Jean-Louis FORT President of the Financial Action Task Force (FATF). Francesco GIAVAZZI Professor of economics at Bocconi University (Milan). Jean-Pierre HALBRON Former Deputy Chief Executive Officer of Alcatel. Emmanuel HAU Member of the Executive Board of Compagnie Financière Edmond de Rothschild. Philippe HILDEBRAND Member of the Governing Board of the Swiss National Bank. René KARSENTI Director General of Finance at the European Investment Bank (EIB). KOK SONG Managing Director of Government of Singapore Investment Corp.

7 AGENCE FRANCE TRÉSOR / Annual report Profile / Key figures _ profile AGENCE FRANCE TRÉSOR Our mission: managing the State s debt and cash in the best interest of taxpayers and under the most secure conditions possible. Our strategy: Taking a long-term view and working closely with the financial community. AFT does not try to beat the market. Our commitment: a guaranteed liquid market, complete transparency, innovation and security. CASH MANAGEMENT POLICY Based on an agreement with the Banque de France to ensure optimum yield on deposits; With a target of a balance of EUR 100 million on the State s single account at the end of each day with some EUR 22 billion moving through the account each day. ISSUANCE POLICY Upholding France s long-held values of transparency, regularity and simplicity; Innovating to build an integrated interest rate market in the euro area. RISK MANAGEMENT AND BACK OFFICE UNIT Managing risks inherent in financial transactions; Ensuring proper execution of transactions. ETHICS All public sector and private sector personnel adhere to strict ethical commitments; Internationally renowned firms conduct periodic audits.

8 08 09 key figures OPERATIONS Resources and investments in agents including 21 civil servants 8.6m incl. 2.6m in IT system investment TRANSACTIONS Total number of transactions (cash transactions, auctions, interest rate swaps, repos and syndicated transactions) ,500 transactions 44 per day ,817 transactions per day CASH MANAGEMENT Daily average of debits and credits posted to the State s account 22bn per day 22.5bn per day Daily average of local government transactions posted to the State s account 1.5bn per day 1.722bn per day Percentage of these transactions with advance notice 91% 91% Total number of investment transactions 9,700 transactions 8,462 transactions Average end-of-day balance Target 100 million 119m 105m Interest on investments Deposits EONIA EONIA Reverse repos Swap EONIA Swap EONIA - 1bp

9 AGENCE FRANCE TRÉSOR / Annual report Profile / Key figures _ DEBT Net borrowing requirement 112.8bn 113bn Issuance of BTF Treasury bills 220.7bn 202bn 52 auctions 52 auctions Weighted average rate 2.04% 2.11% Net issuance of BTAN and OAT bonds 121.6bn 110bn (par value) 29 auctions 30 auctions +1 reverse auction +1 syndic. transaction +1 syndication +2 reverse auctions Weighted average rate 3.71% 3.18% Outstanding negotiable debt (end 2005) 877.3bn* incl. 56.5% held by non residents *including indexation value Apparent average cost (medium-term and long-term fixed rate debt) at 31 December 2005: 4.74% Interest rate swaps outstanding at 31 December 2005: 51.9bn Average residual maturity of debt at 31 December 2005: Before swaps 6.73 years after swaps 6.62 years NET COST OF DEBT Outturn Initial Budget Act 2006 Budget Bill (under the LOLF) Net cost after interest rate swaps 37.8bn 39.5bn 38.7bn Gross cost of negotiable debt 40.2bn 42bn 41.5bn Interest paid on correspondents deposits 304 million 349 million 400 million Investment income and interest earned on account 494 million 460 million 379 million Income from interest rate swaps million 347 million 510 million

10 10 11 RISK MANAGEMENT 37 incidents out of 8,117 transactions These incidents had no negative impact on the Treasury s account. PROMOTION OF TREASURY SECURITIES roadshows Belgium, China, Germany, Iceland, India, Japan, Netherlands, Portugal, Saudi Arabia, Singapore, Southeast Asia (Hong Kong, Taiwan), Spain, United Kingdom, United States (East coast) and United States (West coast) roadshows Australia, Canada, China, Denmark, Eastern Europe (Bulgaria, Hungary, Slovenia), Finland, France, Germany, Iran, Italy, Japan, Middle East, Netherlands, Norway, Southeast Asia (Hong Kong, Macao, Malaysia, Singapore), Sweden, Switzerland, United Kingdom and United States CONSULTANCY IN Hedging the Ministry of Finance s contributions to international organisations Hedging the Ministry of Defence s oil risk Advisory services for various public bodies ANCV (National Agency for holiday vouchers) EMC ( Entreprise Minière et Chimique ) FFIPSA (Farmers Social Benefit Fund)

11 AGENCE FRANCE TRÉSOR / Annual report Profile / Key figures _ COOPERATION AND TRAINING IN 2005 Continuation of the twinning programme for new and future EU Member States (Czech Republic, Romania) Bilateral technical assistance (Chile,Tunisia) Delegations hosted at AFT (Australia, BCEAO - Central Bank of West African States - Cambodia, Chile, Indonesia, Laos, South Korea, Ukraine, Viet Nam) REDEMPTION PATTERN OF MEDIUM- AND LONG-TERM GOVERNMENT DEBT At 31 December 2005, par value ( bn)

12 12 13

13 AGENCE FRANCE TRÉSOR / Annual report Macroeconomic environment_ Sustained world economic growth_ Chapter 1 Macroeconomic environment SUSTAINED WORLD ECONOMIC GROWTH DESPITE RISING OIL PRICES After enjoying very strong growth in 2004, the world economy continued to grow at a sustained pace in According to projections by the International Monetary Fund, the world economy grew by 4.3% in 2005, following growth of 5.1% in As was the case in 2004, growth was unevenly distributed. The United States and China were the two main engines of the world economy, whereas growth in the euro area was slower and failed to reach its potential. Some of this strong growth can be attributed to accommodative fiscal policies, abundant liquidity, improved financing terms and big rises in asset prices, particularly real estate prices. THE UNITED STATES AND CHINA DRIVE WORLD ECONOMIC GROWTH Household consumption and business investment continued to fuel strong growth in the United States. Consumers continued to spend lavishly, causing a further dip in the household saving rate, which hovered near zero and then became negative in the autumn. Hurricane Katrina seems to have had a moderate impact on economic growth, even though part of the oil industry was hit very hard. The strength of American economic growth came at the cost of a deepening of the current account deficit, which went from -5.7% of GDP in 2004 to -6.1% of GDP in In addition to the big drop in the household saving rate, the deepening deficit stems from the poor state of America s public finances; according to the IMF, the US general government deficit stood at 3.7% of GDP. Yet, the exchange rate of the dollar against other leading currencies did not fall. The dollar even appreciated against the euro (see figure 1). [figure 1] Current account deficit as a % of GDP /99 09/99 Current account balance as a % of GDP 12/99 03/00 06/00 09/00 12/00 03/01 06/01 09/01 12/01 03/02 06/02 09/02 12/02 Euro / Dollar 03/03 06/03 09/03 12/03 03/03 06/03 09/03 12/03 03/04 06/04 09/04 12/04 Yen / Dollar 12/

14 14 15 There was some debate about the causes and consequences of America s current account deficit. The new Fed Chairman, Ben Bernanke, who was appointed to replace Alan Greenspan at the end of the year, suggested that the deficit was not the result of a saving shortfall in the United States. He argued that it stemmed from a global saving glut, caused by weak demand in Japan and the euro area, and, more generally, by the ageing of the world s richest economies. The Chairman s diagnosis has been hotly contested, but there is no denying that the American current account deficit must be looked at within the broader context of the world economy. The current account surpluses of emerging economies continue to finance America s deficit. The emerging economies, starting with China, have made a huge contribution to world growth. Some economists deemed that China s economy was overheating in 2004, but it continued to post strong growth. China s GDP expanded by nearly 9% in 2005, following a growth rate that ultimately stood at nearly 17% in China asserted itself as the essential link between Asian countries and the industrialised countries, since the latter s imports ultimately determine the strength of Asian exports. EUROPE FAILED TO REACH ITS POTENTIAL FOR GROWTH Growth in the euro area stood at 1.4%. This growth was unevenly distributed between the countries in the area and it fell short of its potential. The year was a disappointing one for the major countries, with 0.2% growth in Italy and 0.9% growth in Germany, whereas the minor countries flourished, with Spain posting 3.4% growth, its strongest growth since 2001, and Greece posting 3.5% growth. France s economic growth was in line with the euro area average of 1.4%, according to the French national statistics institute, INSEE. As in previous years, France s growth was driven by domestic demand, with a 2% increase in household consumption. The depreciation of the euro, which started in early 2005, had a positive impact on the euro area s foreign trade and gave businesses a strong boost.

15 AGENCE FRANCE TRÉSOR / Annual report Macroeconomic environment_ Sustained world economic growth_ [box 1] MARKET INFLATION EXPECTATIONS Inflation expectations on financial markets were kept in check, and even eased somewhat in The European ten-year break-even inflation rates (1) decreased very slightly from 2.15% to 2.05%. Higher oil prices had a very moderate impact on consumer prices and monetary tightening by the ECB helped to curb the level of break-even inflation rates. (2) The markets mediumterm inflation expectations eased overall from 2.20% to very close to 2%, despite ups and downs over the year (see figure). It should be explained that these measurements of expectations include an inflation risk premium that is hard to evaluate in practice. This means that the fall of 20 basis points in 2005 could just as well be the result of a smaller risk premium as agents become less risk adverse, for example, but still maintain their mediumterm expectation of 2% inflation. INFLATION HELD IN CHECKS Global GDP growth was strong, despite the big rise in oil prices, which reached nearly 70 dollars a barrel on American markets, before easing later (see figure 2). [figure 2] /05 02/05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 Price of Brent in USD Price of WTI in USD The economy withstood this shock primarily because less of the increase in oil prices was passed on to end consumers. The average increase in prices around the world was under 3.6% in The American inflation rate stood at 3.4% and the rate in the euro area stood at 2.2%. Inflation expectations on financial markets were also kept in check (see box). Overcapacity, greater diversification of energy supplies, competition from countries with lower production costs, such as China, and the credibility that central banks have built up in the fight against inflation all helped to keep the inflation that usually comes with strong growth in check. [figure 3] Changes in the break-even inflation rate and the real yield on the European inflation index-linked 10-year bond (%) / /05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 Real yield on OATi 2015 (left-hand scale) Break-even inflation rate OAT i 2015 (right-hand scale) (1) The break-even inflation rate is the difference between the nominal rate and the real rate on indexed-linked OATi or OAT i bonds with the same maturities. (2) Holding strategies mean that break-even inflation rates are still influenced by price changes during the year, reflecting some of the seasonal nature of consumer price indices.

16 16 17 GLOBAL TREND TOWARDS FLATTER YIELD CURVES Monetary policy followed different tracks in North America and in Europe. The Federal Reserve raised its rate by 200 basis points, while the European Central Bank raised its rate by only 25 basis points right at the end of the year. MONETARY POLICY IS LESS ACCOMMODATIVE OVERALL Strong growth and a fresh surge in inflation spurred the Federal Reserve to tighten its monetary policy further. Starting in June, the American central bank raised its key Fed Funds rate from 2.25% to 4.25% in several stages (see figure 4). Meanwhile, the Bank of England lowered its rate by 25 basis points. The European Central Bank, on the other hand, tightened its monetary policy slightly in It decided to start raising its key rate against the backdrop of rising oil prices and a 2.5% year-on-year rise in European prices in October. In the autumn, the European Central Bank s pronouncements took on an increasingly rigorous tone to prepare the market for a rate increase, which finally came in early December, when the Bank increased its key rate by 25 basis points, taking it from 2% to 2.25%. [figure 4] Refinancing rates of the leading central banks (%) /01/05 24/01/05 14/02/05 US Federal Reserve 07/03/05 28/03/05 18/04/05 09/05/05 30/05/05 20/06/05 11/07/05 01/08/05 22/08/05 12/09/05 03/10/05 24/10/05 14/11/05 Bank of England European Central Bank 05/12/05 26/12/05 The increase in euro area short-term rates turned out to be smaller than the rise that market operators were expecting at the end of A review of three-month Euribor futures shows that the market overestimated the three-month rate by 20 basis points on average (see figure 5). This stems in part from the slowdown in economic growth as oil prices started to rise.

17 AGENCE FRANCE TRÉSOR / Annual report Macroeconomic environment_ Flatter yield curves_ [box 2] THE YIELD CURVE: THE CONUNDRUM AT THE LONG END OF THE CURVE Ever since the United States Federal Reserve started raising its rates on 30 June 2004, the American yield curve has been growing steadily flatter. The hike in the Fed Funds rate did not have the expected impact. This situation even led to an inversion of the American yield curve, which echoed the inversion of the British yield curve. Some empirical studies show that this inverted yield curve may be a sign that operators are expecting an economic recession, since the slope of the yield curve is considered to be a leading indicator of economic growth. But, the Federal Reserve thinks that the reason for the flattening lies elsewhere: Abundant liquidity on various financial markets, Investors preference for the long or very long end of the curve, despite relatively low returns. This change stems from structural changes in some countries, including ageing populations, and changes in pension fund and insurance regulations that encourage these institutional investors to buy long-dated bonds. [figure 5] Actual three-month euro rates and expected rates derived from Euribor futures (%) /05 06/05 09/05 12/05 03/06 06/06 09/06 12/06 03/06 06/06 09/06 Past or current rates Note: the maturities of futures contracts are shown on the x-axis. For example, on 31 December 2004, the March 2005 future contract predicted a rate of 2.2%. This turned out to be higher than the actual rate, which was 2.1% when the contract expired. No 2006 futures have matured yet. GLOBAL TREND TOWARDS FLATTER YIELD CURVES 31/12/2004 Actual rates Overall, new or continued monetary tightening has not caused long-term yields to rise. Substantial tightening by the United States Federal Reserve has had only a moderate impact on long-term yields, which have greater influence over saving and investment than short-term rates do. Long-term yields automatically rose following the Federal Reserve s rate hikes, but they were still at very low levels. The former Chairman of the United States Federal Reserve, Alan Greenspan, called this phenomenon a conundrum. In the euro area, the longer end of the yield curve flattened even further. The ten-year yield fell and the slope between two-year and ten-year maturities was one third of what it had been (see figure 6). [figure 6] Slopes of American, British and European yield curves 2-10 years /00 08/00 02/01 08/01 02/02 08/02 02/03 08/03 02/04 08/04 02/05 08/05 02/06 US Euro Area UK 12/06

18 18 19 As was the case in 2004, low rates in the euro area were sustained by rising oil prices. Despite the oil-driven surge in inflation, rising oil prices continued to worry business condition analysts. The slowdown in growth held rates down. Economic growth in Europe slowed. According to the multi-year projections for the Budget Act, growth would stand at 1.4% in 2005, as opposed to 2.1% in Expectations of strong demand from investors for long-dated bonds as they seek to extend the duration of their asset portfolios contributed to the flattening of the European yield curve, particularly beyond ten years. As was the case in 2004, expected changes to pension fund regulations caused a surge in buying pending the transposition of the European Directive on Institutions for Occupational Retirement Provision, called the Pension Funds Directive, into national laws. The regulatory changes, like the changes concerning Dutch insurance companies and pension funds on 1 January 2007, (3) will lead such institutions to improve the maturity match between their assets and liabilities and to mark them to market. At this point, it looks as if most purchasers of long-dated bonds are anticipating the needs of pension funds and insurance companies, (4) since the demand from pension funds will emerge very gradually. [figure 7] Euro yield curve /05 02/05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 01/06 10-year rates 30-year rates Issuers are meeting this demand pragmatically, as the many longer-dated bonds from sovereign and corporate issuers show. France, followed by the United Kingdom, issued 50-year bonds, and several other countries resumed their issuance of 30-year bonds. However, sovereign issuers have indicated that their ability to alter the structure of their financing programmes is limited. They need to issue benchmark securities covering the entire the yield curve, including the short end. (3) In the Netherlands, the duration of pension funds liabilities is estimated at 15 to 16 years, whereas the average duration of their interest-rate products portfolios is less than five years. This means that there is a 10-year duration gap to be closed. (4) According to the Dutch central bank, Dutch pension funds extended their duration very little in The increase was only 0.6 years, following an increase of 0.75 years in One of the reasons for this was that their average solvency ratio increased in 2005 as a result of rising stock prices, which eased some of the pressure to close the duration gaps in their balance sheets. According to some primary dealers, Dutch pension funds and insurance companies are likely to need between EUR 100 billion and 200 billion.

19 AGENCE FRANCE TRÉSOR / Annual report Macroeconomic environment_ Flatter yield curves_ BOND FINANCING TERMS ARE VERY ATTRACTIVE ONCE AGAIN France, along with Germany and Spain, enjoyed the best financing terms in the euro area in 2004 and the early months of The figure below shows that the relative advantage enjoyed by France, Germany and Spain compared to the average for the euro area, increased steadily throughout 2005, following a period of convergence. Financing terms in the euro area continued to converge until the middle of The stabilisation of spreads since then stems partly from fiscal changes, with countries where the government deficit shrank the most, such as Spain, enjoying the biggest benefits, offsetting some of the advantage that France and Germany enjoy because of the liquidity of their bonds. Another reason for the stabilisation of rates was the general alignment of governments financing terms and those in the euro area interbank sector (interbank rate). On the other hand, the range of spreads has widened since the second quarter of This divergence can be explained by the re-evaluation of Greece s public finances in conjunction with Eurostat and the deterioration of Portugal s economic situation, which led to a downgrade of its Standard & Poors rating in March 2005, along with Fitch s announcement of a negative watch on Italy s rating in July This development is significant because is marks the end of the steady narrowing of the differentials between European interest rates that has occurred since the introduction of the euro. It could herald a period where investors are more fastidious about credit risk. [figure 8] Spreads compared to average financing terms in the euro area (%) Average financing terms in the euro area /02 07/02 09/02 11/02 01/03 03/03 05/03 07/03 09/03 11/03 01/04 03/04 05/04 07/04 09/04 11/04 01/05 03/05 05/05 07/05 09/05 11/06 01/06 Germany France Spain Greece Italy

20 20 21

21 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ Chapter 2 Managing the State s debt: regularity, transparency and innovation Agence France Trésor s objective is to minimise the cost of debt for taxpayers in the medium term and under the most secure conditions. AFT s strategy for achieving this objective relies on dynamic management of bonds and interest rate risk management using a portfolio of derivatives. Debt management performance is measured using objectives that combine security and effectiveness. The policy for the primary issuance of State debt must suit investors demand, while upholding the principle of regularity and transparency, to ensure deep and liquid market for Treasury securities, thus enabling France to issue debt at the lowest cost to the taxpayer. THE ISSUANCE PROGRAMME IS CARRIED OUT AS ANNOUNCED The issuance programme to cover the following year s borrowing requirements is published at the end of each year and it always gives due consideration to the need to ensure the liquidity of the securities issued. In keeping with the announcements made in 2004, the usual issuance pattern continued in 2005, with issues of two 5-year BTANs, two or three 2-year BTANs, two 10-year OATs and a longer dated OAT with a maturity of 15 or 30 years, depending on demand. The auction calendar was also followed, with fixed-rate OATs being issued on the first Thursday of each month and BTANs and inflation linked OATs being issued on the third Thursday of each month, except in August and December. In addition, a new 3-month BTF security was issued every other week and then tapped again the following week, 6-month and 12-month securities were auctioned each Monday. As is customary, all of the auctions were prepared in close collaboration with the primary dealers ( SVT ). Highlights of 2005: After decreasing sharply in 2004, the amount of outstanding BTFs was fairly stable in 2005, falling by EUR 1.8 billion, from EUR 97.1 billion to EUR 95.3 billion, which was more than enough to ensure a deep and liquid market for these securities. In 2005, the gross amount of medium-term and long-term borrowing reached EUR billion in cash flow terms, including EUR 58.8 billion in fixed-rate OATs and EUR 18.6 billion in inflation-linked OATi and OAT i bonds, as well as EUR 50.8 billion in BTANs.

22 22 23 A record EUR 16.9 billion in OATs and BTANs was bought back at two reverse auctions and through a number of over-the-counter operations. Most of the buybacks involved securities maturing in 2006 (EUR 14.1 billion in all). The total net medium-term and long-term issuance amount announced for the 2005 borrowing programme was met, as was the case in previous years, with net issuance of EUR billion versus the announced amount of EUR 111 billion. One of the key features of 2005 was European investors growing appetite for longdated and very long-dated securities. AFT took advantage of this particularly strong demand to issue the OAT 4% April 2055 in February. This was the first 50-year sovereign bond to be issued by a G7 country in recent times and it was broadly welcomed by the markets (see 2004 Activity Report). AFT was able to tap the issue three times, in July 2005, January 2006 and April 2006 (see Table 1). The bond s performance on the secondary market was testimony to investors appetite for it. The interest rate differential between the OAT April 2055 and the OAT April 2035 was inverted between February 2005 (+0.03%) and January 2006 (-0.03%), as Figure 2 shows. In addition, a new benchmark 15-year bond, the OAT 3.75% April 2021, was created in May The outstanding amount of this issue stood at EUR 9.3 billion on 10 January Successive taps of the OAT 25 April 2055 Date 22 February July January April 2006 TOTAL Amount 6bn 2.8bn 1.6bn 0.870bn 11.3bn Yield 4.21% 3.77% 3.59% 4.14% 4.01% Method Syndication Auction Auction Auction [figure 1] OAT 2055 Yield (%) /05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 01/06 02/06

23 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ [figure 2] Spreads (in %) /01 02/02 05/02 08/02 10/02 01/03 04/03 07/03 10/03 01/04 04/04 07/04 10/04 01/05 04/05 07/05 10/05 01/06 differential swap differential OAT CONTINUED GROWTH OF THE MARKET FOR INFLATION-LINKED BONDS Demand for inflation-linked bonds remained strong in As in 2004, this demand stemmed from the asset and liability management concerns of pension funds and insurance companies, as well as investors need to diversify their portfolios. In France, the demand for the OATi was boosted by changes to regulated savings; since 1 August 2003, the interest paid on such savings depends on the short-term interest rate and French inflation (excluding tobacco). The banks that distribute such savings products hedge some of their commitments using inflation-linked bonds. The strong growth of inflation-linked bonds has also created a market for inflation derivatives, such as inflation swaps. The inflation-linked bond issuance programme continued in AFT devoted nearly 17% of its net issuance of medium-term and long-term bonds to OATi and OAT i bonds, which was higher than the announced minimum of 10%, but slightly lower than the 20% proportion in The issuance programme also featured a new 10-year bond linked to the French CPI (excluding tobacco). The OATi 25 July 2017 was issued by auction in September As was the case in 2004, these issues were made at regular intervals, with a monthly auction held on the same day as the BTAN auction. This standardized issuance calendar provided the same regularity, predictability and transparency as for conventional bonds. Inflation-linked bonds provide several advantages for the issuer. First of all, the issuer does not have to pay the inflation premium that investors demand as insurance against inflation-related erosion of the real value of bonds. In addition to this savings, inflation-linked bonds can help smooth out the budget balance. This is because at the low point in the business cycle, the fiscal deficit tends to grow, but this can be partially offset by lower debt service and small provisions for inflation-linked debt,

24 24 25 [box 1] Preliminary economic and financial research by AFT, notably in cooperation with some primary dealers, seems to bear out this theoretical advantage (5). The research is based on a risk management model in a stochastic environment. The various borrowing strategies are compared in terms of cost and risk. For this purpose, an econometric model is estimated to describe the macro-financial environment for debt management. The model is then used for stochastic simulations of a large number of possible future scenarios. By applying a given borrowing strategy to the various scenarios, we obtain the associated cost and risk measurements. Of course the cost can be measured as the average long-run interest expense in GDP points, but the risk measurement must represent the variability of these expenses. In practice, several risk measurements can be considered: variability of interest expense or the fiscal balance over a given period, volatility (size of the variations from year to year) or else dispersion (mean deviation from a central value). Cost and risk measurements can be made by simulating a large number of macro-financial scenarios and applying several borrowing strategies corresponding to different proportions of outstanding inflation-linked debt. since inflation usually rises and falls with business activity. Inflation-linked bonds can also attract a more diversified investor base. Syndicated issues have shown that the proportion of non-european investors is higher in the case of inflation-linked OATs. The proportion of non-residents holding inflation-linked OATs stood at 55.5% in 2004, and even reached 69.1% in the case of OAT i, as opposed to 49.1% for all OATs. The market also continued to grow in 2005, as can be seen in Figure 3, which shows virtually exponential growth of total trading volume on the secondary market for inflation-linked bonds. Average monthly trading volume was up by 40% between 2004 and [figure 3] Total secondary market trading volume in inflation-indexed bonds OATi-29 OAT i-12 07/99 11/99 03/00 07/00 11/00 03/01 07/01 OAT i-32 CREATION OF A MARKET FOR PRIVATE INVESTORS OATi-13 OAT i-20 11/01 03/02 07/02 11/02 03/03 07/03 11/03 OATi-51 OATi OAT i-15 03/04 07/04 11/04 03/05 07/05 At the end of 2005, AFT, working in partnership with Euronext and the primary dealers, set up a secondary market in Treasury securities for individual investors. The market opened on 2 January 2006, enabling individual investors to buy and sell OATs as easily as they would shares, with the same guarantees of transparency, liquidity and disclosure as those provided to bond market professionals. The primary dealers act as market makers and liquidity providers. They undertake to quote a narrow bid-offered spread at all times and to act as counterparties for orders up to EUR 500,000. Eight primary dealers have stepped forward: Barclays, BNP Paribas, Calyon, HSBC, Ixis CIB, Natexis - Banques Populaires, Société Générale and UBM, along with two Dutch market makers: Binck and Van der Moolen. The involvement of the major distributors and on-line brokers in this market provides individual investors with direct access to a wide range of fixed-rate OATs, inflation-linked OATs and zero-coupon OATs, with maturities ranging from 2 years to 50 years. These financial intermediaries have undertaken to provide financing 12/ bn per month (5) Une modélisation analytique des stratégies d endettement de l Etat, Jean-Paul Renne et Nicolas Sagnes, Diagnostics Prévisions et Analyses Economiques, No. 99.

25 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ [box 1] This gives the following results: An increase in the proportion of inflation-linked bonds decreases the average interest expense, since the State is selling inflation insurance and thus saves the risk premium. But the variability of this expense is greater because of greater exposure to inflation. However, the influence of the inflation-linked proportion of debt on the variability of the fiscal balance is not as clear cut because of the fiscal smoothing effect. The simulations suggest that an increase in the proportion of inflation-linked debt up to 20% of total outstanding debt could reduce both the cost and fiscal variability. The preceding estimates are fairly robust overall, regardless of the methodological choices made, but they rely on many assumptions about the dynamics of macroeconomic and financial variables over the coming decades. Furthermore, they cannot be used to quantify the impact of other elements, such as diversification of the investor base or the service provided to the market by broadening the range of hedging instruments available. terms that are in line with those provided for equities transactions and to provide individual investors with simple educational tools about investing in OATs. AFT has produced a Guide for Individual Investors to help investors understand the mechanisms of the interest rate markets. It has also produced a simulator that enables investors to calculate bond yields. This information is available from the AFT and Euronext websites: and ACTIVE PROMOTION OF TREASURY SECURITIES AFT, working with the support of the primary dealers, implements an active policy to promote Treasury securities by taking part in roadshows and meetings with investors. Such activity is aimed as much at explaining the government s perception of the economic environment in its role as an issuer as it is aimed at promoting the AFT s financial products to the world s leading financial institutions. This activity is especially important when new issues are launched. In practice, inflation-linked bonds and the creation of the OAT 2055 have given rise to the most questions and new interest. Roadshows in 2005 took AFT staff to the United States, the Middle East, Southeast Asia, Australia, China and Japan in response to the renewed interest of investors from these areas in euro-denominated financial securities. Naturally, AFT staff took part in roadshows to most of the European countries as well. AFT also continued its technical cooperation with Central and Eastern European Countries. THE STATE S ASSUMPTION OF SOME OF THE DEBTS CONTRACTED BY PUBLIC ESTABLISHMENTS Senator Paul Girod, Special Rapporteur for the Senate Finance Committee, released a report entitled Consolidated management of State s debts in June This report expresses concern about the fragmented management of the debt of French central government agencies. It also highlights the multitude of bodies with borrowing and refinancing powers and resulting added cost for the public purse (6). The same concern was expressed in the report on government debt that the Minister of the Economy, Finance and Industry commissioned from Michel Pébereau (7). Several steps have been taken to address this concern. To start with, the State assumed the debt of EMC (Entreprise Minière et Chimique) on 1 January 2006, taking on the total outstanding bonds of EUR 690 million. On 31 December 2005, the State also assumed EUR 2.5 billion of the EUR 3.2-billion line of credit to the Caisse Centrale de la Mutualité Agricole (CCMSA, Central Mutual Insurance Fund For Farmers) under the special budget for farmers social benefits, so as to pay down the debts of the FFIPSA (Farmers Social Benefit Fund). The line of credit was paid off in January (6) Senate Communiqué of 26 October 2005 (7) See Rapport Pébereau at

26 26 27 MANAGING THE AVERAGE MATURITY OF DEBT Agence France Trésor has managed the average maturity of debt since The average maturity of debt has become relatively long as a natural consequence of the need for a liquid market for each issue, growing demand from investors for longdated assets and management of refinancing risk. With a steep yield curve, meaning higher long-term rates and lower, but more volatile, short-term rates, reducing the average maturity of the debt makes it possible to reduce the average interest expense in the long run, all else being equal. But the trade-off is an increase in the variability of the interest expense. In working to reduce the average maturity of outstanding debt, AFT must strike a balance in this trade-off between lower interest expense and greater variability of interest expense. Such a reduction must be achieved gradually over a period at least as long as a full business cycle, since the level of interest rates varies according to changes in business conditions. However, the general conditions prevailing on the interest rate market since the early summer of 2002, particularly with regard to interest rate volatility and levels, mean that AFT can no longer satisfactorily reduce the average maturity of debt by using interest rate swaps. The Minister of the Economy, Finance and Industry therefore decided to suspend the swap programme in September 2002 and immediately informed the National Assembly and Senate Finance Committees of his decision. Since then, market conditions have not been right for a resumption of the swap programme and no transactions have been concluded to increase the swap portfolio since July On the other hand, short-term interest rate swaps that were originally entered into in 2001 and 2002 were renewed when they reached maturity. The average debt maturity management strategy, which means deviating from the spontaneous average maturity, is a long-term strategy that needs to give due consideration to conditions on interest rate markets. The combination of historically low interest rates and investors very strong appetite for long-dated bonds in 2005 militated in favour of extending the average maturity of debt deliberately and AFT s issuance reflected this situation. The OAT 2055 has enabled France to lock in rates over 50 years at levels that have historically been more closely associated with borrowings maturing at ten years or less. If the market returns to more average conditions, the active debt management strategy will once again aim at reducing average maturity. This will mean a resumption of swaps, after an appropriate announcement to the market, once the right market conditions, as measured by the results found with the model developed in 2001, have returned. The primary issuance policy, combined with a suspension of interest rate swaps, led to an increase in average maturity after swaps from 6 years and 33 days at the end of 2004 to 6 years and 228 days at the end of The swaps portfolio produced earnings of EUR 479 million, which reduced the cost of the debt in 2005.

27 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ [box 2] MOST ACTIVE PRIMARY DEALERS IN 2005 Since 2003, Agence France Trésor has conducted an annual evaluation of primary dealers according to three criteria: performance on the primary market for Treasury securities, performance on the secondary market and the quality of service provided to AFT. The assessment is the starting point for an annual evaluation meeting with each primary dealer. A total of 100 points were awarded to the 21 primary dealers. The points were weighted 40% for participation in auctions, 30% for activity on the secondary market and 30% for qualitative considerations. On this basis, the primary dealers that scored more than the theoretical average of 4.76 points were: 1. BNP Paribas 2. Barclays Capital 3. Société Générale 4. Deutsche Bank 5. HSBC 6. IXIS CIB 7. Calyon 8. UBS 9. ABN AMRO 10. Crédit Suisse 11. JP Morgan Note: Further information about primary dealers performance with regard to each criterion was released in 2005 and can be viewed at the AFT website [figure 4] Average maturity of debt (in years) /01 05/01 09/01 01/02 05/02 09/02 01/03 05/03 09/03 01/04 05/04 09/04 01/05 05/05 09/05 01/06 Before swaps DEBT MANAGEMENT INDICATORS After swaps The Minister of the Economy, Finance and Industry proposed a set of debt indicators to the Parliament, after many discussions between AFT, the Finance Committees of the two chambers of Parliament, and the State Audit Office. These indicators are used for performance evaluation under Programme 117 Cost of Debt Service and State s Cash Position. More details can be found in the documents appended to the 2006 Budget Act (8). OBJECTIVE 1: SECURING COVERAGE OF THE ISSUANCE PROGRAMME The issuance programme is mostly covered by auctions attended by banks that act as primary dealers. The first objective is to make sure that these auctions cover the State s borrowing requirement all year long, with an adequate safety margin. Consequently, the first indicator is defined as the number of uncovered auctions and the target is 0. It is also possible to measure the security of auctions by comparing the volume of bids to the amount auctioned. For this, OATs and BTANs should be distinguished from BTFs, which show higher bid-to-cover ratios on average (Indicator 2). All of Agence France Trésor s auctions were covered in 2005, with a high bid-to-cover ratio of 236% for medium-term and long-term debt. This achievement is the result of the confidence established with the primary dealers, regular contacts with French and international investors and careful preparations for each auction. This bid-to-cover ratio is one of the highest in the euro area. In forecasts, the thresholds set for bid-tocover ratios are in line with the levels at which the market deems that an auction is well covered. (8) The 2006 annual performance plan for the Cost of Debt Service and State s Cash Position Programme can be viewed at which provides a detailed description of AFT s management targets and performance indicators.

28 28 29 Indicator 1: Uncovered auctions Actual Forecast Actual Forecast Target Number Indicator 2: Average bid-to-cover ratio Unit Actual Actual Forecast Target BTF auctions % OAT and BTAN auctions % OBJECTIVE 2: IMPROVING BOND DEBT MANAGEMENT CHOICES Over the fiscal year, AFT needs to reconcile the State s borrowing requirements with the auction schedule. This means that AFT must make choices as to the pace of programme implementation over the year and the selection of maturities issued on a given auction day. The objective is to make the most efficient choices possible. AFT calculates the following two indicators to measure the efficiency of its issuance choices: The timing indicator compares the results obtained with the actual issuance policy to the results that would have been obtained by implementing the issuance programme in a linear fashion each day. Therefore, the actual results are compared to those of an automated system that would issue a constant volume of the full range of maturities each trading day so that, by the end of the year, it has issued the same outstanding amount of each maturity as the AFT has under its issuance policy. In this case, any positive or negative differences in the AFT s actual performance revealed by this indicator would stem from its timing choices, as well as from the fact that auctions are held on predetermined dates for operational reasons. The allocation indicator compares AFT s actual strategy to the strategy set out in the line-by-line issuance programme that AFT proposes at the beginning of the year. The indicator compares the differences in the end-of-year value of the portfolio of securities actually issued and the value of the portfolio set out in the programme as originally announced. Both portfolios would have been issued at the same dates, but they would contain different proportions of the various maturities. This indicator measures the consistency of AFT s choices in response to primary dealers advice and the specific market conditions that caused AFT to deviate from its original programme. Both of the control systems reflect the specific results associated with one of the two parameters left up to AFT s judgment: the distribution of the overall issuance volume (9) The average bid-to-cover ratio is equal to the average ratio of bids to allocations for each auction, weighted by the volume issued.

29 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ over time and the selection of maturities issued at each auction. The differences between the performance of the actual issuance and the simulated issuance of each maturity are measured at market value for both indicators in order to integrate both the resulting interest savings and the expected interest savings in the future. The performances for each product and each maturity are then expressed in comparison to a synthetic 10-year benchmark rate in order to facilitate the interpretation of the various results. The latter are expressed in 10-year equivalent basis points. A plus sign (+) indicates that the AFT performed less well than the control systems. These simulations incorporate conventional medium-term and long-term bonds, as well as more innovative products, such as inflation-linked bonds and interest rate swaps. However, BTFs, which are issued in a virtually linear manner with very regular volumes each week, are not covered by this analysis for the time being. The timing indicator shows that AFT s results in 2005 were close to that of the control system. AFT performed better than the control system by 1.6 basis points. AFT obtained the same cost as the control system in the 15-year bond segment and for inflation-linked bonds. It obtained interest savings of 1.4 basis points on the 5- year bond segment and savings of 0.3 basis point on the 2-year segment, and it did less well than the control system on the 10-year and 30-year segments. Indicator 1: Timing Difference between the performance of the actual strategy and that of a simulated linear issuance programme (measured at market value and expressed in basis points) Actual Actual Forecast Target 10-year equivalent b.p to to -10 [figure 5] 10-year OAT auctions and changes in financing terms 3.90% 8, % 7, % 6, % 3.50% 5, % 4, % 3, % 2, % 3.00% 1, % 0 01/05 02/05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 01/06 Issuance volume ( m) Rate (left) Average rate Forecast volume m

30 30 31 Allocation indicator: the 2005 results show that AFT posted a similar performance to that of the control system. AFT beat the control system in the 5-year and 15-year segments. On the other hand AFT underperformed the control system in the 2-year and 10-year segments. Indicator 2: Allocation Difference between the performance of the actual issuance programme and the simulated performance of the reference strategy set at the beginning of the year (measured at market value and expressed in 10-year equivalent basis points) Actual Actual Forecast Target 10-year equivalent b.p to to -10 It should be noted that AFT has very little room for manoeuvre in practice. It has to issue a given volume of securities and its action must be predictable in order to avoid taking the market by surprise. This means that, in practice, it cannot aim at large fluctuations around the simulated control results. Furthermore, the market reacts to changes in supply and demand and anticipates them. This means that the yield of bond starts to rise as soon as an issue is announced. Consequently, a strategy that is passive, with linear issuance or issuance according to a preset programme for the year, is bound to perform less well than the control system. It also follows that any launch of a new issue will be detrimental to actual performance compared to the simulated control system. These constraints must be kept in mind when interpreting the targets and the results. OBJECTIVE 3 (FROM THE TAXPAYER S POINT OF VIEW): MANAGING THE AVERAGE MATURITY OF DEBT AFTER SWAPS The indicator used for this purpose is the average maturity of the State s negotiable debt after swaps. The average maturity of debt after swaps continued to increase, rising from 6.1 years at the end of 2004 to 6.6 years at the end of This increase stems from continued issuance of all of the maturities in demand, the issuance of 50- year OATs and stabilisation of the amount of outstanding BTFs. The objective is to attain an average maturity after swaps of 6.0 years by the end of 2006, but this only makes sense if favourable market conditions return and swaps consequently resume. This would require a decrease in average maturity after swaps of 0.5 years, which has been the target set each year since 2001, given the effects of the suspension of the programme in the middle of 2002 and the increase in the actual average maturity since then. After 2006, the swap amounts must be determined so as to avoid having a substantial impact on the market and the targets for subsequent years must be set in accordance with the performance achieved in the current year. Indicator 1: Average maturity of debt after swaps Actual Actual Forecast Target Year na

31 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ AVERAGE MATURITY AND DURATION AFTER SWAPS Changing the average maturity of debt alters the sensitivity of the debt and interest expense to changes in interest rates. The best indicator for measuring this sensitivity is duration. Duration is calculated as the average maturity weighted by cash flows or as the present value of the coupon payments and principal weighted by the time until the payments are made. The duration of the debt after swaps stood at 5.2 years at the end of This was an increase of 180 days compared to Years Average maturity after swaps Duration after swaps CHANGES IN THE STATE S DEBT COST OF DEBT Interest rates stabilised at low levels over the last three years. This means that volume effects (with the increase in outstanding debt) and interest rate effects offset each other. The net cost of debt increased by only EUR 0.69 billion between 2004 and 2005, even though the amount of outstanding negotiable debt increased by EUR 42.4 billion. It is quite exceptional for such conditions to persist so long and they cannot be seen as sustainable. In any event, the only way for interest rates to go is up. Sensitivity of interest expense to an increase in interest rates For France, a 2% increase in interest rates after 2007 would lead to a EUR-9.0-billion increase in interest expense on its negotiable debt in 2010, which is equivalent to half of a GDP point. [figure 6] Impact of a permanent interest rate shock of 1% and 2% on Interest expense (from 2007) ( m) 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, Permanent interest rate shock of 1% Permanent interest rate shock of 2%

32 32 33 [figure 7] Interest expense according to different deficit scenarios ( m) 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, Assumption 1: 46.8 bn deficit over Assumption 2: 23.4 bn deficit over Assumption 3: 0 bn deficit over Variations in market interest rates affect the average yield on negotiable debt. The table below provides an indication of the cost of medium-term and long-term debt issued each year. This interest rate is calculated by determining the average yield of all of the debt securities issued in a given year, weighted by the outstanding amounts (10). It is the actual cost that the State must bear in future years as a result of issues in the year under consideration. Average yield varies as a function of market conditions and thus does not say anything about the quality of debt management. Therefore, it is not included as one of the performance indicators Weighted average yield of the year s 4.31% 4.00% 5.23% 4.73% 4.58% 3.64% 3.71% 3.18% OAT and BTAN issues (10) Excludes inflation-linked securities and short-term securities (BTFs).

33 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ CHANGES IN BORROWING REQUIREMENTS AND FUNDING SOURCES The 2006 borrowing requirement will be EUR billion, which is EUR 8 billion more than in 2005, but smaller than in The government s decision to allocate EUR 10 billion in privatisation proceeds to paying down the debt in 2006 will mean that this sum is allocated to the Government Debt Fund, a public establishment run by AFT for the purpose of paying down government debt. FLOW OF FUNDS TABLE EUR billion Flow of funds completed completed completed completedcompleted completed Budget table published Act in December 2005 BORROWING REQUIREMENT Redemption of medium/long-term debt (1) OATs BTANs Redemption of debts assumed by the State (1) New State commitments Budget deficit (cash basis) (2) FUNDING SOURCES Medium/long-term issues (3) Net change in BTFs Change in correspondents deposits Change in Banque de France account (4) Other funding sources (+) or borrowing requirements (-) Source: Public Accounting General Directorate, Agence France Trésor (1) Par value (2) Figures reported on 31 December of each completed year do not correspond to outturn deficits, which include the additional period. (3) Net of buybacks, par value (4) Includes short-term investments. A plus sign indicates a reduction in the outstanding amount.

34 34 35 CHANGES IN OUTSTANDING AMOUNTS AND THE STRUCTURE OF THE DEBT The par value of the State s debt stood at EUR billion at 31 December The debt had increased continuously since the end of the 1970s, rising from EUR 44.4 billion at 31 December Date End 2003 End 2004 End 2005 End 2006 (forecast) OATs BTANs BTFs Total negotiable debt FORECASTS OF OUTSTANDING DEBT It should also be noted that the steady increase in government debt is the result of a snowball effect of continued borrowing, even in years when economic conditions were good. This consolidation phenomenon, with the successive addition of annual deficits means that the State is facing an uneven level of debt redemption between 2006 and This is not the result of a temporary peak in borrowing, but a lasting increase in the level. This is shown by a simulation of the projected redemption pattern over time. The pattern was determined, at the end of the first half of 2005, as part of France s commitments under the European stability programme for and based on a conventional assumptions i.e. no change in the issuance programme structure in Redemptions are likely to be greater than EUR 90 billion throughout the period from 2010 to 2013 and are even likely to increase. [indicator 2] Negotiable debt projected redemption pattern ( m) at end 1993, 2005 and 2008 (up to 2036) End 1993 End 2005 End

35 AGENCE FRANCE TRÉSOR / Annual report Debt management _ Regularity, transparency and innovation _ [box 3] COMPARISON OF SOVEREIGN GOVERNMENT DEBT LEVELS Since there are no coherent data on government debts, comparisons in Europe are only possible on the basis of general government (11) debt. France s general government debt stood at EUR 1,065.7 billion, or 65.6% of GDP at 31 December Table 1 shows that France s general government debt ratio fell between that of the European Union as a whole and that of the euro area. General government debt as a % of GDP, as notified to the European Commission Euro area (12 countries) EU (25 countries) France Government debt as a percentage of GDP increased in both the European Union and in the euro area in 2004, following a decrease in Six countries (Portugal, Germany, Greece, France, Luxembourg and the Netherlands) posted an increase in their ratio last year. International comparisons beyond the borders of the European Union are a delicate matter since the components of debt may vary from one country to the next. For example, the OECD presents a table of gross financial liabilities of general government, but stresses that comparisons are difficult because of differences in national data. According to the OECD s table, the ratio stood at 63.4% of GDP in the United States at 31 December 2004 and at 157.6% of GDP for Japan, which has seen a steady rise since In France, the ratio given was 73.2% in 2004, compared to 71.1% in (11) General government covers the central government, various central government agencies, local governments and their entities, and the social security funds.

36 36 37

37 AGENCE FRANCE TRÉSOR / Annual report Cash management _ Active management of the State s cash position _ Chapter 3 Active management of the State s cash position ENSURING THE STATE S FINANCIAL CONTINUITY AND USING ITS CASH HOLDINGS IN THE BEST INTEREST OF TAXPAYERS The Constitutional Council set out the management objectives for the State s cash in its ruling of 29 December 2003: The advance notice requirement instituted by the law in question is designed to improve management of the State s cash position through better anticipation of major cash flows into and out of the Treasury account and thereby making more effective use of the funds deposited with it by local and regional authorities and their public agencies. In so doing, this obligation contributes towards making good use of public funds, a requirement that has constitutional value. It is also designed to help avert the possibility of a negative balance on the Treasury account, thereby complying with Article 101 of the Treaty establishing the European Community, which prohibits the Banque de France from granting advances to government agencies. This ruling highlights and provides a legal basis for the two objectives set for the State treasurer: ensuring the State s financial continuity and active management of its cash holdings. AFT ensures that the State s cash position is always adequate to settle the financial transactions posted to the single account under the most secure conditions. For this purpose, AFT monitors revenue and expenditure flows totalling more than 20 billion per day in real time. This monitoring enables AFT to oversee the daily posting of the State s and Treasury correspondents cash positions to the Treasury account at the Banque de France. One of the distinguishing characteristics of management of the State s cash holdings is that it encompasses the activity of the State in the strictest sense, as well as all of the financial flows of Treasury correspondents, the largest of which are local authorities and local and national public establishments.

38 38 39 Transactions relating to primary debt [box 1] THE INSTRUMENTS MANAGED BY AFT UNDER THE TERMS OF THE CONSTITUTIONAL LAW ON BUDGET ACTS (LOLF) AFT manages three special accounts: I - The Cost of Debt Service and State s Cash Position programme and the trading account for State Debt and Cash Management GENERAL BUDGET Programme Cost of debt service and state s cash position Trading account Section 1: Balance: Section 2: Balance: State debt and cash management Transactions relating to primary debt Cash management Estimated overdraft State debt and cash management transactions involving futures Capped overdraft Replenished 3 times a month Action 1: Action 2: Action 3: Balance recorded in Estimated appropriations Negotiable debt Non-negotiable debt State s cash position Capped expenditure Uncapped expenditure BUDGET ACT

39 AGENCE FRANCE TRÉSOR / Annual report Cash management _ Active management of the State s cash position _ The trading account for State Debt and Cash Management records transactions under two sections. The first section records transactions relating to management of the State debt and cash position, except for futures transactions. Three times a month, the first section of the account is replenished from the Cost of Debt Service and State s Cash Position programme in the general budget. This makes it possible to track the net cost of debt in the general budget, which is put at billion in the initial 2006 Budget Act. The second section of the account records State debt and cash management transactions involving futures carried out as part of currency or interest rate swaps, or the buying and selling of options and futures on government securities. II- Cost-sharing account Advances to Various State Agencies or Bodies Managing Public Services Advances granted from this account provide the State with cash to meet occasional and urgent needs to ensure the continuity of government action or to take emergency measures. Yet, there is no time limit on the advances. Such advances require certainty about the funds that will be used to repay the advance (certainty about the amount and certainty about the legal and technical possibility of raising the funds) and financial neutrality for the State. This neutrality is achieved by charging interest on the basis of the State s cost of short-term borrowing. The cost-sharing account is a mission that will be divided into three programmes in These programmes will cover advances to the central agency for agricultural intervention bodies (ACOFA, 13.5 billion), State services (including the additional budget for civil aviation, 230 million) and other bodies managing public services ( 100 million). III Trading account for Hedging the State s Financial Risks This trading account records futures transactions carried out to hedge the State s exchange rate risk and price risks that affect the implementation of its action in specifically identified ways. This trading account does not record transactions relating to the management of the State s negotiable and nonnegotiable debt or its cash holdings. At present, the transactions have been used to hedge France s contribution to the International Development Association (IDA), and to hedge oil supplies for the military fuel unit.

40 40 41 Treasury correspondents transactions account for half of the daily flows posted to the single account. [figure 1] Local authorities & public establishments 26.8% Deposits & Loans Fund 5.2% 26.8% Other deposits 41.2% State 0.1% La Poste At the close of business each day, the consolidated balance of the State s flows and the Treasury correspondents flows must be positive. Furthermore, AFT, like any other treasurer, seeks to obtain day-to-day financing for the State on the best financial terms. For this purpose, it invests temporary cash surpluses on the interbank market, determines the need for Treasury bill (BTF) issues and, when necessary, conducts repo transactions or provides unsecured loans on the interbank market. Optimising cash management is based on proactive management of the State s cash flow, which is characterized by a mismatch between revenue and expenditure flows over the year. The current expenditure of the State and Treasury correspondents is spread relatively evenly over the year, while tax revenues and the revenue and expenditure flows relating to debt management are concentrated around a few key dates. [figure 2] Revenue, expenditure and refinancing transactions on the Treasury account in 2005 ( m) 50,000 40,000 30,000 20,000 10, ,000-20,000-30,000 12/04 01/05 02/05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 Net revenue (revenue - expenditure) Account balance Net debt balance (issuance - redemptions and interest payments)

41 AGENCE FRANCE TRÉSOR / Annual report Cash management _ Active management of the State s cash position _ [box 2] THE BANQUE DE FRANCE, THE STATE S BANKER The Banque de France is the State s banker. It performs this function under the terms of an account agreement. The present version of this agreement came into force on 1 May The agreement specifies the terms for the State real-time monitoring of movements totalling an average of 20 billion per day on its account, including revenues, expenditures, and refinancing and investment transactions. The agreement is based on the principles of information, security and neutrality. The rules in place ensure that the State s account balance does not decline after 4.15 p.m. due to the belated posting of urgent transactions. Furthermore, the Banque de France must compensate the State for the cost of any errors. The Banque de France, the Public Accounting General Directorate and Agence France Trésor review implementation of the account agreement on a monthly basis. To cope with this uneven pattern, AFT modulates its Treasury bill issuance, which is the main tool for meeting the State s cash requirements throughout the year. At the same time, AFT invests cash surpluses. In 2005, for example, it carried out 8,500 transactions on the money market. These transactions included unsecured loans, repos and reverse repos with its primary dealers, and loans to a number of governments in the euro area. [figure 3] Treasury Account in 2005 (in millions of euros) 50,000 40,000 30,000 20,000 10, /05 02/05 03/05 04/05 05/05 06/05 07/05 08/05 09/05 10/05 11/05 12/05 Account Balance Reverse repos Loans to primary dealers Loans to euro area governments The transactions with primary dealers are made through competitive tenders and counterparties are chosen on the basis of price, or if prices are equal, on the basis of the best transaction security. The revenue from such investments totalled some million in This revenue is deducted from the gross cost of the State s debt. In millions of euros 2005 % Revenue from loans to primary dealers Revenue from reverse repos with primary dealers Revenue from loans to euro area governments Even though the balance on the State s account with the Banque de France must be positive at the close of business each day, compliance with this legal requirement must be reconciled with the State s financial interests. Uninvested cash holdings left on the single Treasury account earn interest at a contractual rate that is lower, on average, than the interbank market interest rate. Therefore, AFT limits the credit balance on the single account as far as possible by applying the zero cash management principle to the State s cash holdings. Fine-tuning the cash balance depends directly on the accuracy of the information available to AFT about transactions that are likely to be settled during the course of the day. In 2005, AFT continued its drive to improve cash flow management that started in 2003 with the rules governing the immediate crediting of cheques and continued in 2004 with Article 117 of the 2004 Budget Act, which requires local authorities to give advance notice of financial transactions exceeding 1 million. As part of the amendment of the agreement governing the transaction account of the Central Bank

42 42 43 of West African States (BCEAO), the principle of advance notice was introduced for the Bank s investment transactions. The procedures for giving advance notice are similar to those applying to local authorities, but adapted for international relations. Furthermore, as part of the amendment of the Decree on public accounting general regulations, plans call for a similar advance notice requirement to be introduced for national public establishments. RESULTS ARE IN LINE WITH THE OBJECTIVES APPROVED BY PARLIAMENT Parliament uses three indicators to assess AFT s cash management performance. (12). OBJECTIVE 1: INVEST TEMPORARY STATE CASH SURPLUSES FOR THE BEST RETURN [figure 4] Breakdown of AFT s transactions in % Reverse repos 17% Unsecured loans to primary dealers and euro aera governments The average return that AFT obtained on its cash investments in 2005 was equal to the average rates on the interbank market for overnight loans (EONIA), and for reverse repos (SWAP EONIA). The return was in line with the management objectives for loans and exceeded the target by 1 basis point in the case of reverse repos Target Unsecured loans EONIA EONIA EONIA EONIA EONIA EONIA (DEPOSITS) -0.02% % % Reverse repos SWAP SWAP SWAP SWAP SWAP (REPOS) EONIA EONIA EONIA EONIA EONIA -0.08% -0.02% % -0.02% (12) The annual performance objective for the 2006 cost of the State debt and cash management programme is available at It provides a detailed description of AFT s management objectives and performance indicators.

43 AGENCE FRANCE TRÉSOR / Annual report Cash management _ Active management of the State s cash position _ [box 3] THE STATE S ACCOUNT: A SINGLE ACCOUNT AND 7,747 SUB-ACCOUNTS In financial terms, the State s cash position is made up of the balance of all of the financial transactions carried out by some 5,500 public accountants, who each hold one or more transaction accounts. As of 31 December 2005, the Treasury account was made up of 7,747 transaction accounts. In its capacity as the State s banker, the Banque de France centralises these transactions in real time and posts them to a single account called the Treasury Account. In practice, the transactions posted to the State s account correspond to: State budget transactions, such as tax and quasi-tax revenues, current expenditure and capital expenditure; Treasury correspondents transactions, meaning the transactions of bodies that are required to deposit their funds with the central government (local authorities, national and local public establishments, etc.); AFT s transactions relating to medium- and long-term financing for the State and management of its cash holdings (redemption of bonds at maturity, interest payments, margin calls, debt issues, buybacks, loans, repo transactions, etc.). OBJECTIVE 2: LIMITING THE END OF DAY CREDIT BALANCE ON THE STATE S ACCOUNT WITH THE BANQUE DE FRANCE The end-of-day balances (13) averaged 105 million, compared to the AFT s management objective of 100 million and the average end-of-day balance of 112 million achieved in [figure 5] End-of-day balance on the single Treasury account ( million) Target OBJECTIVE 3: ADVANCE NOTICE FROM TREASURY CORRESPONDENTS OF TRANSACTIONS POSTED TO THE STATE S ACCOUNT The advance notice requirement for local authorities gave rise to a new indicator that tracks the percentage of transactions exceeding 1 million that were notified by 4 p.m. on the preceding day. Percentage of local authorities Treasury Account transactions in excess of 1 million notified in advance Target 91% 91% 91% 95% (13) Balance excluding days where the market rates are lower than the rate in the account agreement and the days when the balance of the French overseas départements note-issuing bank (IEDOM) is offset.

44 44 45

45 AGENCE FRANCE TRÉSOR / Annual report Risk Management Rigorous real-time monitoring of transactions _ Chapitre 4 Risk Management RIGOROUS REAL-TIME MONITORING OF TRANSACTIONS The State is not a financial institution, but Agence France Trésor s business activities and risk profile make it similar to a financial institution. The French Banking and Financial Regulation Committee s recommendations on risk management (set out in Regulation CRBF 97-02, as amended by the Decree of 31 March 2005) seem to be perfectly apt for AFT, once the necessary adaptations have been made. AFT continuously monitors its transactions for compliance with legal and regulatory requirements, for compliance with risk limits, for supervision of proper execution and posting to the Treasury Account with the Banque de France, and for the existence of an accurate and scrupulous audit trail. THE SAME ORGANISATION AS FINANCIAL INSTITUTIONS In line with accepted banking practices, AFT s administrative processing of its transactions, which is called back-office processing and includes monitoring of settlements, validation, confirmation, pre-recognition of trades and dispute resolution, is separate from its risk management function, which determines the organisational framework and procedures for controlling the various risks incurred, performs second-level controls, ensures compliance with risk limits, and compiles reports on these subjects for AFT s general management. Two levels of internal control The rules set by the French Banking Commission call for the AFT s line units to set up internal control systems. This means establishing functional separations between initiation, validation and auditing of transactions, and the creation of an audit trail. Risk management also requires oversight of the procedures for dealing with public and private-sector institutions and bodies with regard to exchanges of information or settlement of transactions. The partners in question are the Banque de France, primary dealers and the Euroclear securities settlement systems. The AFT is also in contact daily with the Central Treasury Accounting Agency, which keeps the accounting records of its transactions.

46 46 47 Two external audit procedures Under the terms of the 2004 Supplementary Budget Act, a contractual auditor s report is appended to the Budget bill each year. The auditor s report covers the trading account, prudential procedures implemented within the AFT and the government debt fund (CDP), as well as the transactions carried out under the allocations made in the Budget Act. The French State Audit Office audited the AFT s financial statements for 2003 to 2005 as part of its audit of the State s accounts. Risk management tools The AFT s Internal procedural manual has been approved by the Director-General of the Treasury and Economic Policy, who is the Chairman of AFT. The manual sets out the standards for conducting transactions, with specific details about the margin call mechanism for repos and derivatives that enable the State to protect itself against the risk of default by its counterparties. The procedural manual also deals with risk limits, risk monitoring procedures and the related reporting requirements. AFT reviews its procedural manual periodically to ensure that it is consistent with developments in its activities. It also submits the manual for comment by the audit firm conducting the annual audit. AFT has supplemented the code of practice that applies to all employees of the Treasury and Economic Policy General Directorate with a set of special provisions that draw on codes of practice from the financial sector. These provisions stipulate special rules applying to anyone working within AFT or on its behalf. ACTIVITY IN 2005 NEW RISK MANAGEMENT INDICATORS Two new indicators have been developed to measure AFT s aggregate risk exposure in the day-to-day execution of its transactions with various counterparties. Changes in these indicators are reported to the AFT Chairman. The first indicator is value-at-risk, which measures the value of transactions where AFT is exposed to risk under extreme market conditions and given default by its counterparties. This indicator measures only the amount that counterparties could default on, and makes no distinctions regarding the probability of default. The second indicator is average loss given default, which measures the expected loss in the event that counterparties default. This indicator weights the value at risk using the probability of default for each counterparty, as estimated by the market.

47 AGENCE FRANCE TRÉSOR / Annual report Risk Management Rigorous real-time monitoring of transactions _ [box 1] The State incurs five types of risk that may affect its account balance. - Market risk: The State incurs interest rate risk in the event of variations that may affect all of its balance sheet and off-balance sheet transactions. - Counterparty risk: This is the risk that a counterparty may default and be unable to honour its financial obligations towards the State. - Forecasting risk: Managing the Treasury Account with the Banque de France requires forecasts of transactions to be carried out on the account over the next few days. Such forecasts rely on the information provided in advance by the AFT s correspondents. Failure to comply with the advance notice requirement can lead to forecasting errors that are detrimental for optimum cash management. - Settlement risk: This is the risk that a transaction may not be settled because of a material error or a failure in the payment system. - Operational and data processing risks: These risks cover errors in the processing of transactions because of a lack of an official procedure, data loss resulting from information system failures, disruptions of telecommunications links, and computer breakdowns. MONITORING NEW TRANSACTIONS WITHIN AN APPROPRIATE PRUDENTIAL FRAMEWORK In 2005, AFT traded in new financial products on behalf of other State entities to hedge their risks. This included the purchase of derivatives on behalf of the Ministry of Defence to ensure oil supplies for the military. Before engaging in this new activity, the AFT compiled a procedural manual specifically for this type of trading that sets out the types of trades that are authorised, risk limits and reporting requirements. These transactions are also covered by AFT s futures markets agreements and are therefore subject to margin calls. IMPLEMENTATION OF AN INTEGRATED COMPUTER SYSTEM TO MANAGE RISK The deployment of the new TRADIX financial software makes it possible to run all risk management tasks from a single platform, including trade valuation, margin call calculations and real-time risk-limit monitoring. The TRADIX functions enhance trade processing security, make clearer divisions between the tasks of different players (traders, back-office operators, accountants, etc.), generate an audit trail and handle a more diverse range of financial transactions than the previous system. TRADIX is the cornerstone for the AFT s new responsibilities under the 2006 Initial Budget Act, which created a new trading account called Management of the State s Financial Risks. OPERATIONAL RISK AFT s back-up systems have been located at the Banque de France since the end of 2003, under the terms of an agreement signed by AFT and the Banque de France. In keeping with the commitment it made last year, AFT defined its processes in 2005 in order to elaborate an emergency operations back-up plan as per the new requirements set out in CRBF Regulation It also assigned ORNESS the task of drawing up the specifications for a back-up plan suited to its needs, priorities and new computer system. The consultations were conducted in public and they will result in the deployment of a new back-up solution by the end of 2006.

48 48 49 [box 2] THE NEW FINANCIAL ACCOUNTING AND REPORTING SYSTEM The new accounting standards with regard to the State s financial liabilities were elaborated by the Task Force on Government Accounting Standards (part of the Budgetary Reform Directorate at the Ministry of the Economy, Finance and Industry) in cooperation with Agence France Trésor. The Government Accounting Standards Committee issued its final approval for the new standards in October These efforts to bring AFT s accounting into line with the new requirements set out under the terms of the Constitutional Bylaw on Budget Acts, and into line with the equally binding standards required for trading on the market, led AFT to adopt the chart of accounts used by credit institutions, with a few adaptations to suit the distinctive characteristics of the State. This now constitutes its accounting manual for debt and cash management. The fact that this work was carried out simultaneously made it possible to eliminate divergences between the two sets of accounting principles. PriceWaterhouseCooper assisted AFT in this task and with the elaboration of its summary financial statements. MANAGEMENT OBJECTIVES AND PERFORMANCE INDICATORS OBJECTIVE 1: ATTAIN A CONSTANT STANDARD OF QUALITY IN RISK MANAGEMENT THAT MINIMISES THE NUMBER OF INCIDENTS Risk management must be up to market standards with regard to negotiable debt management and cash management. The system should spot problems and incidents arising in debt and cash transactions as soon as possible, avert them and measure their impact. This objective is determined by the absolute requirement of having a credit balance on the account with the Banque de France. It is also determined by the range of AFT s transactions, which involve different settlement systems and counterparties in other countries. Two sets of indicators have been developed to assess whether this objective is achieved. Quality indicators relating to the AFT s control system The first sub-indicator lists the number of incidents or violations of internal procedures. The internal procedural manual defines the types of trades authorised, execution procedures, risk limits, powers of signature, and control processes. This qualitative and quantitative indicator tracks different incidents, which are classified under three categories: violation of powers of signature, violations of risk limits and violations of transaction procedures. This is an internal quality measurement relating to AFT s organisation and compliance with requirements. No violations of procedures were reported in The second sub-indicator tracks external ratings of the internal control function. External auditors conduct an annual audit of AFT s operations for this indicator. One of the auditors tasks is to verify that the AFT s procedures are appropriate for its activities and the risks incurred. For this assessment, the auditors refer to CRBF Regulation Their assessment looks at the control system for transactions and internal procedures, the accounting and reporting system, the system for measuring risks and results, and the risk management supervision system. The external auditors report for 2005 upheld the rating awarded in 2004 and deemed that the procedures ensured secure trading and financial reporting. Indicators tracking trade execution incidents Different types of incidents represent varying degrees of risk for AFT. They are classified into three categories. The first sub-indicator tracks the number of incidents that have a negative impact on the balance on the account at the Banque de France, for example, when a counterparty fails to honour its financial commitments. The second sub-indicator tracks the number of incidents that have no impact or a positive impact on the account balance. These incidents are less serious, but they are the sign of a problem nonetheless. For example, AFT may find that its end-of-day balance is greater than expected, and thus be unable to invest the funds or unable to obtain the best return.

49 AGENCE FRANCE TRÉSOR / Annual report Risk Management Rigorous real-time monitoring of transactions _ [box 2] - continued The new management accounting system and the new summary statements will make comprehensive information about the State s debt and cash position available at all times. In turn, this reporting system will help AFT keep pace with the best practices in the market. The success of this accounting reform depends on the implementation of a new computer system and the two projects are being carried out simultaneously. The deployment of the new standards in the TRADIX software will be completed in The third sub-indicator tracks the number of incidents relating to the systems involved in transactions, including failures and problems with AFT s internal information systems, problems with market systems, such as the systems run by Euroclear, or problems with the computer system at the Banque de France. The number of security delivery failures in repo transactions was down from 39 in 2004 to 8 in These incidents had no impact on the investment income earned on the account, which was even improved in most cases. In order to improve market operations further, AFT announced to primary dealers that in the event of failures on their part, the AFT reserved the right to take measures, including outright suspension of the primary dealer in question. AFT has also been working with the French securities settlement system Euroclear France to ensure that it takes practical measures to improve the settlement rate. These efforts, combined with the preliminary decisions, seem to be producing results, as can be seen in the statistics for The system-related incidents stem primarily from problems with connections to the Banque de France applications, market systems (Euroclear) and AFT s internal applications. The objective set for prudential supervision has thus resulted in a decrease in the number of incidents.

50 50 51

51 AGENCE FRANCE TRÉSOR / Annual report SIFT _ New computer system _ Chapter 5 New computer system AFT s new computer system is called SIFT (Système d Information France Trésor). It provides secure, cross-sector, user-friendly and open-ended management of the State s market transactions (issuance, active debt management, investment of cash holdings), and automatic recording of AFT s transactions in the State s accounting system. In the coming months, it will also track the State s account with the Banque de France for cash forecasts, real-time monitoring of account transactions and investment decision-making aids. There are two main modules in SIFT: SIFT Trading and SIFT Cash Management, the former has already gone live and the second has yet to be implemented. SIFT TRADING MODULE This SIFT module is already in use. It is based on the financial software Tradix from GLTRADE and it includes a data repository for generating reports, analyses and statistics using the Business Objects query tool. Implementation of the SIFT Trading module took two years from the award of the contract in early Functions were phased in over time to avoid disrupting AFT s day-to-day operations and to ensure maximum security during the transition from the old system to the new one. In December 2004, the first start-up involved trading and risk management, except for margin calls (front office and middle office activities). The new system handled all financial instruments except interest rate swaps, which were integrated into the new system in March The next stage in the project involved margin call management, which went live in August 2005, enabling monitoring of margin calls for derivatives trading through Tradix. Monitoring margin calls for repos went live in November 2005 and the design of the back-office module started in early The parameterisation and testing phase for this module took place in September 2005 and the module successfully went live at the end of January 2006 (see box). Design work on the accounting module used by the Central Treasury Accounting Agency (ACCT) also started in The module went live in January 2006 and ACCT can now run AFT s 2006 management accounting system, in its capacity as the accountant for the State s trading activity, using SIFT Trading. The SIFT statistical and analytical data repository was compiled throughout the project process. Its functions are all operating and can be used for: - automatic updates of some of the data that AFT posts to its website, - consolidation and formatting of the secondary market trading statistics that primary dealers transmit to AFT each month, - producing operating reports to AFT specifications that are not available as standard features in the software.

52 52 53 Some aspects of the SIFT Trading module still need to be finalised in 2006, such as the automatic interface between SIFT and Euroclear France s RVG securities settlement system and the interface between SIFT and the State s financial accounting system (CGL). Once the work has been completed, the State s financial reporting system will be fully secure, since the same data relating to the State s financial transactions will also be used for the AFT s management accounting system and the State s financial accounting system. SIFT CASH MANAGEMENT MODULE A call for tenders for management of the State s cash position was made in August 2004 and discussions were started with bidders. After examining the bids, AFT chose the bid by GLTRADE, which guarantees full functional coverage through an enhanced cash management module built on the Tradix software. The contract, which runs for 24 months, was awarded in 2005 and work started in September. Plans call for the first run of the SIFT Cash Management module at the end of 2006, followed by the deployment of a second version once the Banque de France has overhauled its customer account management system as part of an ongoing project. Transactions on the single Treasury account and cash notifications will be transmitted via the new Banque de France system and the SIFT Cash Management module.

53 AGENCE FRANCE TRÉSOR / Annual report SIFT _ New computer system _ [box 1] NOTES ON MINOR EVENTS DURING A MAJOR SYSTEM CHANGEOVER WEEKEND AT AFT Paris, 28 and 29 January 2006: On this weekend, AFT and ACCT (AFT s fiscal agent and accountant) were finally ready to put several years of work on overhauling the information system into practice by switching over to the new SIFT back-office and management accounting systems (see above). The front-office and middle-office modules of SIFT had already been running since the end of 2004, but the task this weekend involved the changeover for AFT s whole computer system. The weekend also marked ACCT s accession to its new status of SIFT user from its premises on Paris Left Bank. The start-up meant that AFT and ACCT would now be able to provide data for the State s 2006 accounts automatically from the financial transactions involving the State s debt and cash holdings. The size of the stakes was foremost in the minds of the team during the weekend. The team consisted of ten people from AFT, five people from ACCT, and five people from the contractor GLTRADE, which publishes the software used as the backbone for the new system. Friday 27 January, 7:00 pm: The changeover operation started with the conversion of the Tradix programs and its Sybase database to the new version that includes all of the back-office and accounting functions. But only the team members from GLTRADE were fully involved in this first step because it relied on a migration technique that is the sole property of the software provider. This step was completed late at night amid slices of cold pizza and warm soft drinks. Saturday 28 January, 9:00 am: The team was hard at work following the step-by-step restart procedure compiled by all players. This included the gigantic task of manually entering the transactions already in the SIFT system in order to provide the additional data needed for the back-office and accounting systems. Nearly 10,000 Tradix transactions were generated involving AFT s outstanding contracts. The AFT and ACCT team members used SIFT workstations for the task of manual data entry. They were trained to carry out simple operations and performed repetitive tasks that looked like something out of Charlie Chaplin s Modern Times. Tests were conducted at each stage of the proceedings. 11:00 am: The air temperature in the building dropped dangerously close to that of the freezing outside air. In the trading room, fingers grew numb and the team members shivered. Fortunately, the AFT Secretary General had the foresight to tell the team how to contact the right staff to turn on the heat and the temperature returned to comfortable levels. 12:30 pm: The lunch break did not include any champagne yet, but a good meal and a visit from the AFT Chief Executive boosted the morale of the team. Most tasks were moving ahead on schedule and no delays looked likely. The team was cautiously optimistic. 8:30 pm: A little party was held, as is always the case when teams work under extreme conditions. Musical entertainment was provided by one of the SIFT project leaders who brought out his saxophone and filled the AFT s small meeting room with music, drowning out all conversations. The party was just an opportunity to relax, rather than a celebration, because there were no finished tasks to celebrate yet. The weekend could still turn out to be a failure and lead to more working weekends. Sunday 29 January, 9:00 am: The atmosphere was tense. The back-office driver was supposed to be ready, but it was still running. The whole ACCT team was on tenterhooks. The changeover for the accounting system would take a long time. The later it got the later they would finish. Would they get any sleep before Monday? 11:00 am: The AFT meeting room became the staging point for team members desperate to get to work but so uncertain about when they could start. The breakfast croissants had all disappeared long before leaving only crumbs. Pacing the empty corridors with worried looks, team members exchanged the only news to be had: it s running. 2:30 pm: The management accounting entries were finally available for checking. ACCT accountants were paired up with AFT staff to check the daily accounts one by one. For hours, the AFT trading room echoed with strings of numbers read out while the accountants nod their heads or purse their lips. The readers throats grew dry, their eyes misted over and the words stumbled over their lips. The tension rises as the numbers run together and laughter is seldom heard. 5:18 pm: The test results were in and they were excellent. The notion of success started to emerge. The SIFT management accounting module was up and running. There was no going back now. The production database was backed up at 5:30 pm for safety s sake. It would be a shame to lose all the data at this point. 7:00 pm: The team members started heading for home. That s it; the system s up and running. Everyone knew that a long road lay ahead and that congratulations would have been premature. The AFT s first management accounts would not be closed until December 31, 2006, and there were still many major tasks to accomplish. However, the changeover was still a major step in the alignment of the management entity and its accountant through reciprocal, real-time access to the AFT s management accounts. As a result of the changeover, the AFT now has a new system architecture that is simpler and more efficient. It is, therefore, in line with the objectives announced to Parliament and to the AFT Strategy Committee s meeting. Until the next start-up then.

54 54 55