Market Consultations, Summer 2002: Summary of Comments
Summary
Overall, market participants have a positive view of the consultation process and the debt program initiatives that the government has undertaken in recent years, in particular supporting new bond issuance through buybacks.
Market participants understand that a trade-off exists between supporting a large new issuance program through buybacks and maintaining adequate liquidity in large off-the-run maturities. As a result, many participants suggested that the government limit the amount of a given maturity that can be repurchased.
The majority of participants recommended a modest increase in buyback operations on a switch basis and smaller, more frequent switch operations. Participants supported a further broadening in the range of bonds eligible at each particular buyback operation, as well as broadening the basket of bonds for the pilot cash-management bond-buyback program up to 18 months. Participants also suggested reducing the time period between auctions and the associated buyback operation on a cash basis.
With respect to the bond program, many participants favoured maintaining an annual 10-year benchmark. Most agreed that the government could modestly reduce auction sizes of 2-year benchmark bonds when these are fungible with an existing large, liquid bond.
Participants indicated that no adjustment was desired to the treasury bill program.
BOND-BUYBACK PROGRAM
Supporting new issuance and liquidity of off-the-run bonds
Most participants are of the view that buyback operations geared to support the size of auctions have benefited the functioning of the market for Government of Canada securities.
There is a good understanding that a trade-off exists between supporting a large new issuance program and maintaining the liquidity of large off-the-run maturities. Market participants are generally of the view that having a variety of liquid bonds along the Government of Canada yield curve is an attractive and important aspect of the Canadian market. They were also of the view that maintaining the liquidity of some large off-the-run maturities is useful for pricing corporate and provincial securities, but they agreed that, over time, buybacks are likely to lead to a more general use of on-the-run benchmarks for the pricing of these securities.
Some participants indicated that there may, at times, be a perception that bond-buyback operations could negatively affect the liquidity of large off-the-run maturities. They suggested that the government address this perception by limiting the amount of a given maturity that can be repurchased to a predetermined threshold deemed necessary to maintain liquidity in particular maturities. They also suggested that efforts should continue to focus on ways of buying back older, illiquid, high-coupon issues and on alternatives for maintaining gross issuance.
A few also suggested increasing buybacks at the short end of the yield curve where there is a larger supply of bonds.
Other issues regarding the bond-buyback program
Size and frequency
Most participants recommended that buyback operations on a cash basis continue to take place on the same day as auctions and not be held more frequently. On the other hand, many participants proposed that buyback operations on a switch basis be held more frequently to facilitate participation and the management of dealers' inventories and investors' portfolios.
Maturity Range
Most participants were in favour of further broadening the range of bonds eligible at each particular buyback operation if required. They also recommended that the basket of bonds targeted for repurchase remain consistent from one operation to the next to maintain the transparency and predictability of the program.
Alternative Buyback Methods
There were mixed views regarding the benefits of alternative buyback methods such as taps or coupon passes. Several participants suggested that the government could use the coupon pass method to target illiquid, high-coupon bonds before further expanding the buybacks to large off-the-run maturities. On the other hand, several participants indicated that the effectiveness of these alternative methods might be limited, given that institutional investors hold most of these high-coupon bonds and therefore few would be readily accessible for repurchase. Many participants were also concerned about the transparency, regularity, and consistency of alternative buyback methods especially for larger bond issues.
Some participants suggested that the government be more transparent about its valuation model to help them assess the price at which they should offer securities for repurchase.
BOND PROGRAM and PILOT BOND-SWITCH PROGRAM
New issuance method—auctions and switches
Many participants felt the current balance between new issuance at auctions and switch operations was generally appropriate. However, a desire for a modest increase of the issuance through switches was expressed in order to encourage a broader participation from those who do not participate directly in the auction process. Those in favour of this modest adjustment were of the view that switches offer low-risk access to new issuance and help participants to better manage their inventories.
In contrast, some participants favoured auctions supported by buyback operations on a cash basis over switches, since the combination of the two operations generates more secondary market activity. They also preferred auctions to switch operations, because they do not hold large inventories of bonds that can be switched for newly issued bonds.
Benchmark sizes and time required to build benchmark bonds
Most participants felt that the current target for benchmark sizes and the time required to build new benchmark bonds were appropriate. Some suggested that benchmark bonds could be built by targeting the lower end of the target range. A shorter time to build benchmark bonds would, in turn, help to maintain current coupons and important liquid points along the yield curve. Others indicated that auction size is more important than benchmark size and that less frequent issuance would be preferred to smaller auction sizes.
A large number of participants favoured an annual building cycle for the 10-year benchmark. Others indicated a willingness to adapt to a five-quarter cycle in order to maintain current benchmark size. A few advised that international investors, in particular, would prefer a one-year building cycle for the 10-year benchmark for current coupons, regularity, and comparability. Many participants recommended that creating a 10-year benchmark each year would help to maintain a viable basket of bonds eligible for delivery on futures contracts on Government of Canada bonds (CGB traded on the Montreal Exchange), which would, in turn, be beneficial for the liquidity of the 10-year benchmark in the secondary market.
Fungibility of 2-year benchmarks
Most participants agreed that the issuance of 2-year bonds could be modestly reduced when the 2-year benchmark being built is fungible with an existing large, liquid issue in order to limit the total amount of bonds sharing a given maturity date. The majority of participants recommended that a new 2-year bond with a current coupon be issued rather than a reopening of the existing bond.
Timing and frequency of switch operations
The majority of participants were in favour of spreading out the dates for auctions and switch operations during the quarter in order to increase the frequency of access to new bonds. A few suggested that switch operations be scheduled close to auction dates, since this would focus the liquidity in a maturity sector at one point in time.
In terms of operational timing, there was a consensus that switch operations could be held more frequently and on any day except Mondays and Fridays. There was also a consensus that switch operations could be conducted earlier in the day.
Net position reporting
To ensure market integrity, most participants supported the application to switch operations of a framework on bidding limits and reporting of net positions similar to that which applies to auctions.
OTHER ISSUES
Pilot cash-management bond-buyback program
Market participants were generally in favour of broadening the basket of bonds eligible for cash-management bond-buybacks to include bonds with maturities longer than 12 months to facilitate the ongoing operation of the program. The majority of participants suggested that the basket be expanded to include maturities up to 18 months, while a few suggested that maturities up to two years could be targeted.
Turnaround time
There was strong support for the reduction in the turnaround time for auctions and buyback operations that was announced in the 2002-03 Debt Management Strategy. Most participants were in favour of further reductions in turnaround time. Many expressed a preference for releasing the results at a fixed time following the operation, although a few favoured releasing the results as soon as they are available.
Participants identified the length of time between the start of the auction process and the release of the buyback results as an important risk factor and indicated that reducing this time period would encourage broader participation in the operations.
Treasury bill program
The majority of participants indicated that they were generally satisfied with the functioning of the treasury bill market and felt that no adjustment was required to the treasury bill program. Some participants suggested that treasury bill auctions could be conducted earlier in the day.