Main Principles of Government Debt Management

Government Debt Management at Danmarks Nationalbank manages the central-government debt on behalf of the Ministry of Finance. The central-government debt comprises the domestic and foreign central-government debt, the assets of three government funds, and the balance of the central government's account with Danmarks Nationalbank. Government Debt Management also manages loan guarantees and re-lending to a number of companies.

The overall objective of the government debt policy is to cover the central government's financing requirement at the lowest possible long-term borrowing costs, subject to a prudent degree of risk. Furthermore, the aim is to support a well-functioning domestic financial market and to facilitate the central government's access to the financial markets in the longer term.

The objective of government debt policy implies an ongoing evaluation of the trade-off between cost and risk and is supported by liquid benchmark series.

The government debt policy is based on international best practice for good governance of debt management, including openness, credibility, clearly defined objectives and a clear division of responsibilities.

1.1 GOVERNMENT DEBT

Total government debt comprises the domestic and foreign debt, as well as the assets of three government funds and the balance of the central government's account with Danmarks Nationalbank, cf. Table 1.1.1.

The domestic debt is denominated in Danish kroner. Borrowing in kroner finances the budget deficit and redemptions on previously issued domestic government securities.

The foreign debt is denominated in foreign currency. By far the greater share of the foreign debt is raised in order to maintain a foreign-exchange reserve and is exposed in euro. A minor share of the foreign debt is in US dollars, reflecting re-lending in dollars to Danish Ship Finance A/S.

Except for a small portfolio of mortgage-credit and index-linked bonds held by the Social Pension Fund, the assets of the three funds are placed in Danish government bonds.

The central government holds liquid funds in an account with Danmarks Nationalbank. This account accrues interest at the discount rate.

Government Debt Management also manages re-lending facilities, under which mainly government-owned companies can raise loans, and issues loan guarantees to a number of companies on behalf of the central government. The assets related to re-lending are not included in the compilation of the government debt. Re-lending and loan guarantees primarily support the financing of government infrastructure projects.

1.2 DIVISION OF RESPONSIBILITIES

The Minister of Finance holds the overall political responsibility for central-government borrowing and debt, including relations to the Folketing (Parliament). The actual management of the government debt, as well as related tasks, is carried out by Government Debt Management at Danmarks Nationalbank on behalf of the Ministry of Finance.

The government debt management strategy is discussed at quarterly meetings with the Ministry of Finance on the basis of written proposals from Government Debt Management. The Ministry of Finance subsequently authorises Government Debt Management to implement the agreed strategy. At the meeting in December, the overall strategy for the following year is determined. At the subsequent quarterly meetings, any adjustments and further specifications of the overall strategy for the year are adopted. Follow-up takes place in monthly status reports to the Ministry of Finance and in reports at the quarterly meetings.

1.3 ORGANISATION

At Danmarks Nationalbank, the government debt is managed by the Government Debt Management Office within Financial Markets together with Market Operations, Accounting, Government Debt Accounting and Audit. Government Debt Management is thus divided into front, middle and back offices with separate functions. A clear division of functions and clear procedures reduce operational risks and facilitate internal control. A well-defined division of responsibilities helps to ensure that various categories of professional expertise are utilised in the best possible way, and that tasks related to the management of government debt are undertaken independently of other activities at Danmarks Nationalbank. Box 1.2 summarises the structure of Government Debt Management.

The Government Debt Management Office within Financial Markets is responsible for middle-office functions and formulates the general principles concerning government debt policy, prepares proposals for borrowing strategies and undertakes risk management, etc. The Government Debt Management Office sets out guidelines for Market Operations with regard to sale, buy-backs, swap transactions, etc.

Market Operations is responsible for the front-office functions and thus for the operational parts of the government debt policy, including issuance of government securities, buy-backs, swap transactions, etc.

Back-office functions, such as settlement and bookkeeping, are undertaken by Accounting and Government Debt Accounting.

Government Debt Management is audited by the internal audit department at Danmarks Nationalbank and by Danmarks Nationalbank's external auditors on behalf of the National Audit Office of Denmark. The National Audit Office of Denmark is empowered to investigate whether the accounts of government institutions are sound, i.e. to check that they are without significant errors and discrepancies and to assess whether the funds received by government institutions are applied in the best possible way. The National Audit Office of Denmark publishes the results of its investigations on an ongoing basis, e.g. at www.rigsrevisionen.dk.

On a day-to-day basis, Government Debt Management works closely with the Ministry of Finance in many areas. In addition, Government Debt Management is in ongoing dialogue with market participants in the financial markets and seeks to achieve the best possible infrastructure for issuance of and trade in Danish government securities, cf. Box 1.3.

1.4 DOMESTIC AND FOREIGN FUNDING RULES

The central-government funding rules set out the framework for the distribution and scope of the central government's domestic and foreign borrowing. The rules are described in an agreement between the government and Danmarks Nationalbank. Domestic and foreign funding rules have been determined, and together they support the separation of fiscal and monetary policy.

The domestic funding rule stipulates that domestic borrowing covers the central government's gross domestic financing requirement, i.e. the central government's current deficit and redemptions on the domestic debt. This means that, viewed over the full year, the central government's payments in principle have no impact on domestic liquidity.

The foreign funding rule implies that the foreign borrowing is in principle equivalent to the redemptions on the foreign debt raised in order to maintain the foreign-exchange reserve. Consequently, foreign borrowing does not influence domestic liquidity, but is included directly in the foreign-exchange reserve.

According to Article 101 of the EU Treaty, the central government's account with Danmarks Nationalbank cannot show a deficit. Central-government borrowing is planned to ensure an appropriate balance on the central government's account which can absorb fluctuations in central-government receipts and payments. Uncertainty concerning the balance of the central government's account is e.g. related to predicting the receipts from various taxes.

In the light of e.g. market conditions, the central government may continue to issue government securities even though the borrowing requirement for the year has been financed. In that case, these issuances will cover part of the borrowing requirement for the following year.

1.5 OBJECTIVES AND STRATEGY

The overall objective of the government debt policy is to cover the central-government financing requirement at the lowest possible long-term borrowing costs, subject to a prudent degree of risk. Furthermore, the aim is to support a well-functioning domestic financial market and to facilitate the central government's access to the financial markets in the longer term.

To support openness and credibility regarding government debt policy, it is emphasised that the overall borrowing strategies should be known to market participants. Furthermore, only standardised, well-known instruments are used.

The overall objective for government debt policy is implemented via strategies for issuance and interest-rate risk. The specific objectives are implemented as strategic benchmarks.

Borrowing is based on building up liquid benchmark series in central maturity segments. It is sought to reach a broad investor base.

The issuance strategy is separated from management of the interest-rate risk on the government debt via interest-rate swaps and buy-backs. The strategic benchmark for the interest-rate risk is determined by the duration of the total government debt.

The strategies are assessed on an ongoing basis in order to ensure the best possible compliance with the objectives and that Danish government debt management complies with best practice as formulated by e.g. the World Bank and the IMF.

1.6 RISK MANAGEMENT

Measurement and management of risks on the central-government debt are key aspects in relation to meeting the overall objective. Risk management comprises various types of risk.

Interest-rate risk is managed on the basis of a strategic benchmark for the duration of the total government debt. Duration is a summary measure of the trade-off between interest costs and interest-rate risk. The duration target is established on the basis of quantification of costs and risk in Government Debt Management's Cost-at-Risk model. Duration is managed by using interest-rate swaps that restructure the central government's interest payments between fixed and floating interest rates. Interest-rate swaps from fixed to floating interest rates shorten the duration and normally ensure lower average interest costs, but higher interest-rate risk. In the trade-off, the duration target is supplemented with interest-rate fixing.

Exchange-rate risk is managed by limiting the currency exposure to euro on foreign government debt raised to maintain a foreign-exchange reserve.^[1] In view of Denmark's fixed-exchange-rate policy vis-à-vis the euro, this ensures a low exchange-rate risk.

Credit risk is limited by only transacting swaps with counterparties with high credit ratings who have signed a unilateral collateral agreement.

Operational risk is sought to be minimised by separating the various government debt management functions, and via well-defined and clearly documented procedures. Furthermore, operational risk is limited in that only standardised, well-known financial instruments are used. Legal risk is minimised by using standardised contracts.

1.7 DANISH GOVERNMENT SECURITIES MARKETS

Issuance and buy-back of Danish government securities take place on the MTS platform in a special market segment, MTSDenmark, with primary dealers as counterparties. Primary dealers have a market-making obligation, i.e. they quote current bid and ask prices within fixed maximum spreads and for fixed minimum amounts. Market making contributes to a transparent and efficient market for Danish government securities.

Danish government securities are traded on a number of other electronic trading platforms besides MTSDenmark, and on the Copenhagen Stock Exchange.

Danish government bonds are primarily issued on tap. Tap issuance implies that the central government sells securities throughout the year at the best market prices quoted by the primary dealers.

Treasury bills are issued at monthly auctions. 2005 saw the launch of a new auction system at MTSDenmark. At the same time, a new primary dealer system was introduced in the market for Treasury bills.

Central-government euro loans are issued through syndication whereby a group of banks (the syndicate) is selected to arrange the loan.

1.8 INFORMATION ON THE CENTRAL-GOVERNMENT DEBT

An important element in the government debt policy is to give market participants and the public access to information on the central-government borrowing strategies, borrowing requirement, etc., as well as information of a more general nature on the framework for government debt management. A wide range of information is published on a regular basis, cf. Box 1.4.

An overview of the information regularly published on central-government borrowing and debt is presented in the Appendices.