Select Committee on Treasury Minutes of Evidence

Memorandum by HM Treasury, UK Debt Management Office, National Savings, and National Investment and Loans Office


  The Sub-Committee has invited written submissions on the management of the Government's cash and debt requirements. It is specifically looking at the work of the four bodies which are jointly submitting this Memorandum.

  2.  The invitation to submit evidence mentioned the following issues:

    (i)  Whether the new framework for managing cash and debt established since 1997 will be coherent and effective and whether any further changes are needed.

    (ii)  Whether the Government has sought an appropriate balance between gilts and National Savings products in financing debt.

    (iii)  How appropriate and attractive the products offered by the DMO and National Savings are, to the needs of government and the relevant consumers.

    (iv)  How transparent the system is by which the Government's cash and debt requirements are managed, and what improvements in transparency could be made to facilitate parliamentary scrutiny.

    (v)  How the Treasury carries out its monitoring role and how this could be improved.

    (vi)  What impact the privatisation of the former Paymaster Agency and the National Savings partnership with Siemens Business Services has had on the services provided by these departments.

  3.  The main text of this Memorandum provides an overview of the framework for the government's debt and cash management established since 1997, which builds on previous reforms introduced from 1995. This includes background on the structure of government debt and the wider government fiscal policy framework that governs government borrowing (section 2); the largest borrowing instruments, gilts and National Savings products (sections 3 and 4), debt management policy and the recent institutional changes (sections 5, 6 and 7) and the process and parts of government involved in debt management, and the monitoring and reporting arrangements (sections 8 and 9).

  4.  The new framework for debt and cash management has been carefully planned and we believe it will be coherent and effective. We have no reason to believe that further changes to the basic framework will be needed, however the operation of the system will be closely monitored and the agencies involved subjected to regular review.

  5.  The memorandum addresses the other specific issues set out in paragraph 2 above as follows. Sections 3 and 4 explain the main features of gilts and National Savings products, and how these relate to the government's financing needs and the markets in which the DMO and National Savings operate. Paragraphs 21-24 explain the system which operates to establish the balance between these products. Annexes A and B contain further details of gilts and National Savings products, and the management of them.

  6.  Sections 8 and 9 explain the system by which the Government's cash and debt requirements are managed, including the forms of reporting and accountability, and the methods by which the Treasury carries out its monitoring role. These sections explain how the debt and cash management plans are pre-announced and published to provide transparency and facilitate parliamentary scrutiny.

  7.  National Savings partnership with Siemens Business Services and the privatisation of the former Paymaster Agency are covered in Annexes C and D.

  8.  This Memorandum tries to provide a clear picture of the process and arrangements without burdening the explanation with too much detail. Inevitably, the process of giving a coherent account may mean that some points of detail which may interest the Sub-Committee are not addressed in the main text or even the annexes. We have, therefore, provided a glossary of terms and organisations which may not be immediately familiar. We are also making available to the Sub-Committee the following publications which go into considerable detail should the Sub-Committee require further explanation. These are:

    National Savings Framework Document.

    DMO Framework Document (Revised Version: October 1999).

    Gilt Review 1998-99.

    Gilts: An Investor's Guide.

    National Savings Guide for Independent Financial Advisors.

    DMO Annual Report and Accounts.

    NS Annual Report and Accounts.

    Debt Management Review July 1995.

    Debt Management Report March 1999.

    Consolidated Fund and National Loans Fund Accounts and Supplementary Statements for 1997-98.

    Two documents on "The Future of UK Government Debt and Cash Management":

      —  a proposal for consultation. HM Treasury. 29 July 1997;

      —  a response to consultation. HM Treasury. 22 December 1997.

    Two documents on "The Future of UK Government Cash Management":

      —  Report on Progress. UK Debt Management Office. 30 July 1998;

      —  The New Framework. UK Debt Management Office. 4 December 1998.

  Monthly statistics on Public Sector Finances: A Methodological Guide Debt Management—Theory and Practice. Treasury Occasional Paper No 10.


  9.  The Government finances its net cash requirement through a combination of gilt sales, National Savings products, Treasury bills and an overdraft with the Bank of England (known as the Ways and Means balance). Although the Government's cash financing requirement is currently quite small (the November Pre-Budget forecast of the Central Government Net Cash Requirement for 1999-2000 is £1.1 billion), Central Government gross debt—ie the accumulated stock of its debt—is currently £392 billion (at end March 1999). The cost of servicing this debt, in terms of Central Government debt interest expenditure, is forecast to be £26 billion in 1999-2000.

  10.  Government policy is that borrowing to finance its cash requirement is done in sterling. Borrowing in foreign currency has only been used as a means of financing the foreign currency reserves. Table 1 below shows the total stock of sterling debt and how this is split between different instruments. Chart 1 illustrates the proportions of the various sterling borrowing instruments.

Table 1

Stock held outside CG at 31.3.99
InstrumentNominal £ billion
Conventional Gilts220.0
Index Linked Gilts62.3
Undated Gilts3.1
National Savings63.6
Treasury Bills4.7
Ways and Means15.4
Other sterling11.4
Total sterling debt380.6
Foreign currency debt11.8
Total debt392.4

Chart 1. Composition of sterling debt (as shown in Table 1)

  11.  These various debt instruments are generally issued for different purposes. Governments tend to issue gilts and National Savings products to finance the annual cash requirement, and to issue Treasury bills and vary overnight borrowing (the Government's "Ways and Means" borrowing from the Bank of England) to cope with in-year fluctuations in cash requirements. In practice, however, it is never possible to forecast the cash requirement completely accurately and these short-term instruments also therefore take the strain of forecasting errors. However, the effects of the forecasting errors on short-term debt tend to be unwound in the following financial year. Hence, taking one year with the next, long-term debt is issued to finance the annual net cash requirement, and short-term debt to finance in-year fluctuations. However this general distinction does not form a binding rule—the Government may also choose to adjust the level of short-term debt in its annual issuance plans if it wishes to change the amount of short-term debt in its overall portfolio. (The Government has, for instance, made such an adjustment in its financing plans for 1999-2000, to prepare for the DMO's new cash management operations. This is explained in paragraph 40 below.)

  12.  The Government's new macroeconomic framework, which is designed to ensure macroeconomic stability, has had a profoundly beneficial effect upon debt interest costs. The new fiscal framework has been constructed to deliver sound public finances. This is based on two strict rules: the golden rule (that over the economic cycle the government borrows only to invest and not to fund current spending) and the sustainable investment rule which ensures that public debt is kept at stable and prudent levels in relation to national income. The new monetary arrangements have been successful in reducing both inflation and inflationary expectations. This has been reflected in reduced borrowing costs, which has benefited the public sector, like the rest of the economy. But the way the government conducts its debt management is also an important determinant of the cost.


  13.  Gilts are government bonds which provide the purchaser with a regular income (the annual "coupon", usually paid in two six-monthly payments), and return the principal value on redemption. Because they are government backed and the UK government has never failed to meet its debt obligations, they have a low default risk. When a stock is first issued the coupon is usually set close to the current interest rate. So a gilt first issued in the early 80s might have a coupon of 12-15 per cent compared with 6 per cent for a gilt issued now. Stocks are usually referred to simply by their coupon and maturity date. Hence "8 per cent 2009" refers to Treasury stock maturing in 2009 with an 8 per cent coupon.

  14.  The range of gilts on offer and the structure of the gilts market is described in detail in Annex A. Broadly there are two types of government bond: conventional gilts which entitle the holder to a fixed nominal coupon and Index-Linked Gilts (IGs) where the coupon payments and the principal are linked to the headline Retail Price Index. The Government has also in the past issued floating rate gilts, where the coupon varies according to current interest rates, and undated stocks, where the government can choose the redemption date. Bonds are issued at a variety of maturities. Chart 2 overleaf shows how oustanding gilts of all types are split by maturity.

(Chart 2.  Maturities in CG gilt portfolio at 31.3.99)

  15.  In recent years the Government has tended to issue long, medium and short gilts in roughly equal proportions. Within the last two years of much lower issuance, the limited number of auctions has made it difficult to stick to these precise proportions each year. The Government has recently tended to issue more longer term gilts to reflect the increased demand for them from pension funds. A further explanation of the factors underlying government issuance policy is given in paragraph 27 below.

  16.  There is an active secondary market in gilts where prices fluctuate such that the yield on the gilt reflects market interest rates generally. With the cash flows fixed, the price of the bond rises as the yield falls. The secondary market is of less immediate concern to the Government as issuer than the terms on which it issues new debt. But clearly the yield in the secondary market will be closely related to the yield which the Government achieves on any new issue of gilts and so the Government has an incentive to promote liquidity and efficiency in the secondary market, and to design and sell its gilt products in ways which make them most attractive to end-investors. The main reforms which have been introduced to make them attractive to investors are covered briefly in the section on debt management policy below (paragraphs 30-34) and in more detail in Annex A.

  17.  The main players in the gilt market is illustrated in Chart 3, overleaf. The market in gilts is centred on a group of firms known as "Gilt-Edged Market Makers" (GEMMs).

Chart 3

Debt management organisation and relationships: wholesale markets

   The GEMMs deal continuously with the major professional investors like pension and insurance funds across the entire list of gilts. The GEMMs make the market by fulfilling their obligation to quote continuously buying and selling prices on each stock to any potential investor. In return for fulfilling this, and other obligations, the GEMMs have certain privileges when it comes to auctions (see Annex A). The DMO sell gilts at auctions mainly to GEMMs. However, the DMO hold regular consultations with both GEMMs and end-investors and are concerned with the whole gilt market, both in terms of its efficiency, and the attractiveness of gilt products. GEMMs and end-investors are also invited to annual consultation meetings with a Treasury Minister, to help inform the annual debt management plans, and they are invited to comment to the Treasury directly on the DMO's performance.


  18.  Around 20 per cent of the government's outstanding stock of borrowing has been met through the sale of National Savings products. National Savings products comprise a wide range of retail savings instruments, including deposit facilities (Ordinary Account and Investment Account) available through Post Office counters, fixed rate products (Capital Bonds, Fixed Rate Savings Bonds, Savings Certificates and Pensioners Bonds), and variable rate bonds (Income Bonds). Some instruments pay interest gross and are taxable; some are tax free (though the rate offered takes account of this). Some are designed to produce a monthly income, others are medium-term for accumulating investments. National Savings offers a cash ISA and a unique, highly popular product in Premium Bonds.

  19.  With the ample supply of retail savings products from the private sector, the rationale of National Savings is to help finance the government's net cash requirement, and to do so cost-effectively. Where governments have decided to encourage saving through tax concessions, they have done so across the savings market through PEPs, TESSAs and now ISAs rather than any subsidised National Savings product.

  20.  Although National Savings has a secondary objective to promote Government savings policy, this has tended to be manifest in the style of its funding. For example, National Savings introduced an ISA in order to enhance its product range and competitive position, supporting its primary financing task. But the design of the ISA took full account of the Government's objectives for ISAs: the National Savings ISA meets the CAT standard, caters for a variety of needs (lump sums, regular savings, occasional deposits), is straightforward and has very wide access, including through the Post Office. More generally, the Government requires National Savings to operate "in a manner which benefits both Government and personal savers—now and in future". This means, in practice, that National Savings works to a set of core values: security, integrity, straightforwardness and a "human face" (see Annex B). These values underpin a product range which addresses a wide variety of savings needs, offers fair value, and offers a high standard of service. In this way National Savings supports savers both directly and, by encouraging choice and competition, indirectly. National Savings is also undertaking further work to identify whether there are other ways in which those who do not currently save might be encouraged to do so.

  21.  National Savings' aim is to add value to financing part of the national debt at an overall cost marginally less than through gilts. To achieve this, its products are priced in such a way that it would cost the Exchequer marginally less than the equivalent gilt or short term borrowing rate once the administrative costs of National Savings and any tax advantages are included. Thus a fixed rate National Savings Certificate will normally be priced in such a way that the rate offered is a little less than a 5 year conventional gilt yield, after covering the administrative cost and allowing for the fact that the Certificate is tax free. Similarly, the interest offered on the Ordinary Account will be a little less than the short term variable rate at which the government might have to borrow, again taking into account the cost of providing the facility. The rate offered on any particular product, and the overall reduction in debt interest which can be achieved, depend upon a number of factors including rates offered by competitors for similar products. In 1998-99, through its operations, National Savings produced a saving to the Exchequer of about £100 million compared with equivalent financing through gilts, after covering all administrative costs and the cost of tax foregone.

  22.  The amount of government financing done through National Savings is determined by this pricing policy. Rather than an explicit decision being made as to how much to finance through gilts and how much through National Savings, based on relative costs, the framework ensures that National Savings will not be more expensive than gilt sales. Estimates are then made of how much sales are likely to result on this basis. These estimates are used to construct the assumption about National Savings net financing contribution which is then input into the financing arithmetic which determines the level of gilt sales for the coming year. (This process of setting the gilt sales level is described further in paragraphs 50-52 below). This assumption for National Savings net financing contribution forms part of the remit which is set for National Savings and published in the Debt Management Report each year.

  23.  However, that does not mean that the amount of government financing provided by National Savings is entirely demand-led. National Savings require an indication of how much financing they are expected to do in order to plan their business over the medium-term. In order to provide the basis for efficient operations and business planning, the Treasury has indicated that it is not intending at present to ask for major shifts in National Savings contributions. Even in the event of declining government financing requirements, National Savings should plan on the basis of at least maintaining its real level of deposits (ie keeping deposits level after adjusting for inflation). The gilts market is better placed to cope with changing financing requirements than is the retail arm through National Savings. Imposing a stop/go policy on National Savings could have detrimental effects on its ability to fund, and if its reputation was run down, it may be very costly to build up again. It is therefore asked to retain the potential to increase funding, should the need arise.

  24.  Nevertheless, National Savings must continue to provide the Government with a useful service, in terms of fulfilling its objectives, and the agency will be reviewed in 2000 (in line with the regular review process for an Executive Agency). Unlike the DMO, the remit set does not restrict the maturity mix of National Savings products. Whilst National Savings accounts for 20 per cent of central government debt, or less this is not a major concern. However, financing through National Savings raises the proportion of short-term debt within the government's whole debt portfolio, since National Savings products are either at variable rates, or of fixed rates of interest of up to five years.



  25.  The Government's debt management objective is:

    "To minimise over the long-term the cost of meeting the government's financing needs, taking into account risk, whilst ensuring that debt management policy is consistent with the objectives of monetary policy."

  26.  The emphasis on long-term means that the Government tries to minimise the net present value of debt costs rather than the debt interest bill in the current year, or over the short-term horizon over which it normally presents its public expenditure and fiscal policy plans in the Budget. Given the long-term nature of many of the debt instruments and the importance of an issuer's reputation in debt markets, any tendency to concentrate just on the next few years could have potentially very damaging consequences in future years.

  27  The reference to risk in the objective means the Government does not simply choose a strategy which minimises the expected average debt cost but tries to ensure that the chosen one is robust against different economic outturns. The main way in which the government can influence the composition of its debt portfolio is through the strategy for new issuance which it adopts each year. This sets the proportions of index-linked and conventional gilts and the pattern of issuance across different maturities. Except where there are clear institutional preferences (eg recently, when the maturing of pension funds increased their demand for long gilts), the government is rarely in a position to know for certain that issuing one sort of gilt will prove cheaper than another. The government seldom has any better information about the future path of interest rates or inflation than the market, which will quickly price any information into the relative structure of gilt yields. So rather than trying to beat the market by outguessing how the economy will behave, a more fruitful strategy will usually be for the government to select a portfolio which will protect it against as wide a range of risks as possible. Thus issuing long maturity conventional gilts exposes the government to the risk of locking into interest rates which then fall by more than is expected; whereas concentrating issuance on gilts with short maturities exposes it to the risk of having to refinance large amounts of the portfolio when interest rates are temporarily very high. Index-linked issuance has reduced UK debt costs over the past couple of decades mainly because governments have controlled inflation more successfully than the market anticipated when they bought indexed gilts. Investors may also pay a premium for index-linked gilts because they provide a valuable hedge against inflation. These are all the kind of considerations which have to be brought to bear on the annual decision on the structure of gilts to issue. The Treasury is taking forward a programme of research to identify what systematic analysis can inform its debt management strategy. A working paper on this was published earlier in the year as a Treasury occasional paper. [1]

  28.  The reference to monetary policy means that the Treasury and DMO will not undermine the Bank's delivery of the inflation target (eg by "printing money" to finance the cash requirement; or by the DMO cash management operations obstructing the Bank's money market operations). This constraint on debt management reflects the new arrangements between the Bank and the DMO, following the announcement in 1997 of the separation of responsibilities for implementing the Government's monetary and debt management obectives (which is discussed in paragraph 35 below). However the revision to the debt management objective to take account of that separation was only minor. The 1995 review of debt management policy (discussed in paragraph 30 below) acknowledged that debt management no longer played a major role in reinforcing monetary policy. Further background on this issue is discussed in an article entitled "Government debt structure and monetary conditions" in the Bank of England's November 1999 edition of the Quarterly Bulletin.

  29.  To a large extent the cost of the Government's debt financing reflects prevailing interest rates in the market, both currently and in the past when debt was issued. But there is still scope for Government debt management policy to affect overall cost. Given the size of the Government's debt even small reductions to the rate achieved can potentially yield large savings. Thus lowering gilt yields by one hundreth of one per cent (or a "basis point" in the market jargon) would, once it feeds through across the whole of the debt portfolio, save the Government £30 million a year. Recent reforms (since 1995, see below) have therefore tried to reduce debt interest costs by improving the method of issuance, and the efficiency of the gilt market.


  30.  The Treasury and the Bank of England conducted a major review of debt management policy which reported in 1995. The review heralded the move away from the hitherto highly discretionary policy which the authorities had adopted on debt issuance. The review rejected the argument that the use of discretion was beneficial to the government because it enabled it to borrow the right sort of debt when the price was right. But there is no reason to believe that the government is able to beat the market in this way. Indeed the use of discretion could be costly for the government because market participants will charge the government a premium for the uncertainty over its issuance policy. Therefore the policy advocated by the review was one of promoting efficient, liquid and well-informed markets which encouraged the international investor to participate, with the premium for liquidity shared between issuer and investor. It therefore recommended a programme of annual published remits, setting out in advance what the government planned to issue in terms of maturity and type of gilt, and a pre-announced auction calender with a concentration on sale through auction, rather than through taps. ("Taps" are sales of small amounts of gilts in an unscheduled way, at very short notice.)

  31.  Other reforms since 1995 have also improved the attractiveness of UK gilts. A key strategy has been to concentrate gilts issuance in specific maturities which form large and highly liquid "benchmark" issues and attract a significant premium. Although there are about 50 issues of conventional gilts in the market, at any one time the Government will tend to be issuing only three: one of a short-term maturity of around five years, a medium-term maturity of around 10 years and a long maturity gilt which we are currently issuing with a redemption date of 2028. Once a new stock has been created, the Government will tend to reissue it at subsequent auctions whilst it still falls in the benchmark range. The same gilts sold at different auctions become indistinguishable—a concept known as fungibility. But after a year or so, stocks will have moved out of their benchmark range, so a stock that was originally issued as a five year plus stock will after a couple of years become less than four years and will have lost its characteristic of benchmark status. At that point the Government would tend to issue a new five year benchmark.

  32.  The gilt repo market was introduced in January 1996. A "gilt repo" is a sale and repurchase agreement under which one market participant agrees to buy a gilt from someone else in the market, and sell it back to them at an agreed date for an agreed price. This facility makes it easier for GEMMs to meet their obligations to deliver gilts. It also enables investors to borrow money against gilts security, or to borrow stock for hedging purposes. From the Government's perspective, increasing the attractiveness of gilts to investors should reduce the yield on gilts and reduce the debt interest bill.

  33.  A strips market for gilts was introduced in 1997. This allows someone who holds a gilt (which is an entitlement to coupon payments and repayment of the principal) to trade each coupon and the principal separately. This is another feature which increases the attractiveness of gilts and hence reduces the yields and the government's overall debt interest bill. Nearly all conventional gilts issued since 1994 are strippable. Prior to that date stocks were issued with a variety of coupon dates. Strippable stocks have uniform coupon dates of 7 June and 7 December, so that, when stripped, the coupons derived from different stocks become fungible, (ie indistinguishable and can be traded without distinction), thereby improving liquidity in the strips market.

  34.  The Government has also simplified the tax treatment of gilts, in order to improve the efficiency of the gilts market, and make gilts more attractive to foreign investors. The most significant tax reforms have included the streamlining of the corporate tax system for bonds and gilts in 1995-96, and the payment of all gilt coupons gross of tax from 1997-98. (When foreign investors are paid coupons gross of tax, the idea is not to allow them to avoid tax but to avoid complicated inter-country tax arrangements).


  35.  Unitl April 1998 the Bank of England acted as the Government's agent for selling gilts and managing the gilts market. As part of the announcement which gave responsibility for setting interest rates to the Bank of England in 1997, the Chancellor decided that responsibility for government debt and cash management should pass to the Treasury. This separated the responsibility for monetary policy from debt and cash management. This was done to eliminate any market concerns that the debt and cash operations might use inside knowledge about future interest rate changes, and to ensure that the debt and cash management operations and the monetary policy operations were accountable separately, and delivered clear separate objectives.

  36.  Following a consultation exercise in July 1997, Treasury Ministers decided to set up a new executive agency of the Treasury—the United Kingdom Debt Management Office (DMO)—to carry out debt and cash management operations. The DMO came into existence on 1 April 1998, and took over responsibility for debt management from the Bank of England on that date. As is normal for an executive agency, its relationship with the core Treasury is defined in a framework document. The basic structure is for Treasury Ministers, advised by core Treasury officials, to set the policy framework and an annual gilts remit and leave the delivery and detailed decisions to the DMO, within the term of the remit. (Hence the DMO decides on such details as which stock to auction and when). The Bank of England has retained responsibility for gilts registration, and is also the DMO's agent for gilt settlement.

  37.  Although the transfer of debt management operations from the Bank to the DMO involved considerable organisational change, the transfer was relatively straightforward because there was no change in approach to the basic policy or the way operations were conducted. However the position has been very different for cash management. Previously, the change in the government's daily cash position has been met by varying the size of the government's Ways and Means borrowing from the Bank of England, and the Bank also managed the effect of the government's short-term cash transactions on the banking system as part of their monetary operations. (This is explained in more detail below.) In taking over this responsibility, the DMO have had to establish their own new set of operations to actively manage the government's cash position, and to separate these new operations from the Bank's money market operations. This has involved extensive consultation, and planning, both in terms of the policy of how the operations will work, and the actual implementation of new systems. The necessary policy and new systems are now in place, and the DMO will assume responsibility for managing the Government's short-term cash transactions with the banking system from April 2000, following a transitional period.


Separating cash management out from the Bank's money market operations

  38.  The arrangements for balancing the government's daily cash position are summarised in Chart 4 on page 16, both now, before the separation of cash management from the Bank's money market operations, and in the future (from April 2000), after the start of the DMO's separate cash management operations. The current position, before the separation, is that the Bank's money market operations are geared towards delivering the Monetary Policy Committee's decisions on the level of short-term interest rates, whilst offsetting the effect of the Government's short-term interest cash transactions with the banking system. If the Government's short-term cash transactions do not of themselves create a daily shortage in the money markets, then the Bank creates a shortage by draining liquidity through the sale of Treasury bills. Hence, although Treasury bills are a government debt instrument, the Bank's monetary considerations determine the level of the weekly tender. Having created the shortage, the Bank is in a position to relieve it by lending money to the market at its chosen interest rates. The Bank, acting as the banker for the government, provides the market with sufficient funds to cover its daily cash needs, such that any variation in expenditure or revenue not met by longer term debt instruments, results in a change in the level of the Government's Ways and Means borrowing from the Bank.

  39.  When the DMO start their new, separate cash management arrangements, they will take on the responsibility of managing the aggregate cash flows of government (borrowing short-term on days when the government is a net spender, lending out money on days when revenues are pouring in) in the most cost-effective way without worrying about the effects on monetary policy operations. The Bank of England on the other hand will be assured that the Government's has financed its own net cash position, and will pursue its monetary policy independently of what happens across the government's books. The DMO will use Treasury bills as a means of short-term borrowing, deciding on what length of bill to issue, using information on the likely seasonal pattern of the government's cash flows. However the Bank will also continue to need to drain the market of liquidity through the sale of bills, and thus create the money market shortage. One way of doing this would have been for the Bank to issue its own bills, but the Bank and Treasury have agreed that to have bills which were issued by both the Treasury and the Bank competing in the market would cause confusion and reduce liquidity. The DMO have therefore announced that they will issue additional Treasury bills at the Bank's request, depositing an equivalent sum out of the proceeds with the Bank. This element of the DMO acting for the Bank will be completely transparent such that the market will know, as it does now, precisely what the Bank is doing in terms of draining the market.

Table 2



Bank of England Responsibility

  Bank money market operations balance flows in and out of banking sector (including central government cash flows) and relieve daily money market shortage.

  Change in Ways and Means borrowing from Bank balances central government accounts at Bank.

  Bank issue Treasury bills, as NLF liabilities, to create future money market shortage.

Treasury Responsibility

  EFA forecast daily central government cash flows to inform Bank daily money market operations.


Bank of England Responsibility

  Bank money market operations balance cash flows in and out of banking sector (excluding central government cash flows) and relieve daily money market shortages

  Level of Ways and Means borrowing from Bank frozen, no longer varied each day to balance central government accounts

Treasury Responsibility

  DMO issue (more) Treasury Bills, as DMA liabilities, to smooth future central government cash flows, plus pre-announced amount for Bank, to create future money market shortage.

  DMO daily cash management operations balance central government accounts at Bank of England

  EFA forecast daily central government cash flows to inform DMA cash management operations

  40.  Following consultation on its proposals for the new cash management operations, the DMO has announced that it will use Treasury bills as the main instrument for smoothing the government's cash flow. The government financing plans for 1999-2000 have accordingly increased planned Treasury bill issuance, to prepare for the start of the DMO's cash management operations in April 2000. The DMO has also announced that it will use a combination of money market tenders and bilateral dealings with cash management counterparties to neutralise the remaining net daily cash flows.

  41.  As a consequence of the DMO taking on cash management, the government will cease to use the Ways and Means balance with the Bank of England as a means of day to day cash management. This means that the level of Ways and Means will no longer vary on a daily basis: after the transition to the DMO's cash management operations is completed, the level will remain constant. The Government has also announced that it will then consider paying Ways and Means off. The Ways and Means facility is a special opt out from Stage II of EMU which in general outlaws government borrowing from its central bank. If the UK were to decide to join Stage III of EMU, the Government would have to cease borrowing from the Bank via Ways and Means.

Management of cash within government

  42.  Government cash flows, whether of expenditure, revenue, interest payments or borrowing are based around two central funds: the Consolidated Fund and the National Loans Fund. Like all the main central government accounts these are held at the Bank of England. Chart 5 overleaf shows in simplified form how the various accounts involved in cash management relate to one another. In outline, government revenue from taxation and other sources is collected daily into the Consolidated Fund. Payments out of the Consolidated Fund to finance central government's spending are authorised by Parliament either through Supply Services in the form of Votes or Standing Services. Virtually all of this spending is channelled through accounts held by government departments at the Office of HM Paymaster General, which in turn banks at the Bank of England.

  43.  The National Loans Fund (NLF) is the government's borrowing account. One of its functions is to lend the authorised bodies such as nationalised industries and (through the Public Works Loan Board) to local authorities. The NLF is the fund which formally borrows money for the government. Hence the proceeds of gilt sales by the Debt Management Office and deposits with National Savings are transferred to the NLF. Small sums are also borrowed from other external sources (eg via taxpayers purchasing certificates of tax deposit) and the NLF also borrows in foreign currency to finance and hedge the foreign currency reserves.

Chart 4


  44.  A system is in place known as the Exchequer Pyramid, to ensure that any cash balances which remain in government accounts at the Bank of England at the end of each day are channelled into the main central government accounts to reduce the government's cash borrowing needs to a minimum. If the Consolidated Fund has a surplus at the end of the daily operation this is automatically transferred to the NLF to reduce its borrowing needs. If, on the other hand, the Consolidated Fund is in deficit this is automatically financed by a transfer from the NLF. The NLF will then borrow overnight any remaining cash deposits held in any government accounts (including the accounts held by government departments at the Office of HM Paymaster General).

  45.  When the DMO start to manage central government's daily cash requirements actively, the DMO's objective will be to undertake market borrowing or lending during each day to balance the remaining position on the NLF, after the operation of the Exchequer Pyramid sweeps up cash into the central funds as described above. To achieve this objective the DMO will need reliable forecasts of each day's significant cash flows in and out of central government, and up to date monitoring information on actual cash flows as they occur. For cash management purposes the flows that matter are those which cross the boundary between the Exchequer Pyramid accounts at the Bank of England and accounts elsewhere (ie cross the outer black line in Chart 5 on page 18).

Forecasting and monitoring cash flows

  46.  At present the responsibility for forecasting and monitoring central government cash flows is split between the Treasury's Exchequer Funds and Accounts Team (EFA) and the Bank of England. The Bank is involved for two reasons: firstly, because central government cash flows are currently an important element of the Bank's money market management operations and, secondly, because its own operations give rise to some of the relevant flows. Each week, EFA produce daily forecasts of these flows for the following 15-19 weeks to help the Bank to plan their operations. The forecasts are based on a mixture of firm information, forecasts from other departments and analysis of past trends.

  47.  Throughout the day, EFA also monitor cash flows as they occur and update the forecasts of the eventual outturn. This requires a considerable collaborative effort involving OPG, a number of government departments and the Bank of England reporting actual cash flows during the day to EFA. EFA then has to make estimates of cash flows still to be made later in the day before reporting its forecast outturn periodically to the Bank, who must then adjust their market dealing operations accordingly, after taking account of the remaining flows for which they are responsible.

  48.  When the DMO take on cash management, government cash flows will cease to be a component of the Bank's money market operations; government cash flow forecasting and monitoring will then be split between EFA and the DMO.

  49.  Accurate forecasts will be very important to the success of cash management by the DMO, and EFA have been seeking to involve departments more actively in the forecasts. A scheme is currently being piloted which will give departments incentives to improve the forecasting and management of their cash flows.


The financing arithmetic

  50.  At or shortly after the Budget each Spring, the Government publishes its remit to both the DMO and National Savings, setting out what is expected of them to meet its financing needs over the coming year. These are published in the Debt Management Report. The key to the planning process is the financing arithmetic; an example of which is set out in Table 2 overleaf. This starts with the Central Government Net Cash Requirement, which is derived as part of the Budget forecast. The net cash requirement is not the main focus for the fiscal policy position of the Government, where the key concepts are the current balance and net borrowing, both of which are accruals based concepts. But for the purposes of working out the government's financing needs, a cash based measure is required. Hence the Central Government Net Cash Requirement (formally known as the Central Government Borrowing Requirement) is the key concept for planning the government's financing. A number of adjustments need to be made to the Central Government Net Cash Requirement however, in order to arrive at the gilts sales for the coming year.

Table 3

Central Government Net Cash Requirement (forecast) 6.2
plus expected net financing for foreign currency reserves 2.4
plus expected gilt redemptions14.8
plus residual unwinding excess gilt sales from previous financial year -2.3
Financing Requirement
Less net financing from:
    National Savings0.1
    Certificates of Tax Deposit0.0
    increase in Treasury bills and other short-term debt for cash management 3.6
Gross gilt sales required17.3
of which:
    Short conventionals (3-7 years) 5.0
    Medium conventionals (7-15 years) 3.0
    Long conventionals (>15 years) 5.8
    Index-linked gilts3.5

  Source: 1999-2000 Debt Management Report. Figures may not sum due to rounding.

  51.  First, any change to the Government's holdings of foreign currency, except in so far as it is achieved through changes in foreign currency borrowing, will affect the equation. If the government sells foreign currency and buys sterling, that reduces the amount of sterling required through gilt sales. Second, each year some gilts will fall due for redemption. This means additional gilt sales will be required to refinance them. Third, the policy is usually to reverse any over-financing or under-financing from gilt sales in the previous year which has arisen because the outturn is different from the forecast on which the last gilts remit was based. Fourth, some of the financing needs will be met by changes in the net borrowing through National Savings. Fifth, occasionally other forms of central government borrowing come into the equation (eg sales of additional Treasury bills needed for the DMO's cash management operations). After taking into account each of these factors, the financing arithmetic derives the figure for gilt sales needed over the coming year.

  52.  Having set the overall level of gilt sales required, the DMO remit also lays down how much to issue through conventional rather than index linked gilts, whether to issue any floating rate gilts, and the maturity mix. In setting the proportions within the remit the Government takes account of market views. The Economic Secretary hosts two meetings a few weeks before the remit is set, one seeking the views of investors and the other those of the GEMMs. Together with market views the Government considers what portfolio would best deliver its policy of financing at least cost, having due regard to the risk it runs in terms of different scenarios of economic conditions. Finally, the remit sets out an auction calender for the coming year. This helps allow the investor to plan ahead and delivers the transparency and pre-commitment policy described in paragraph 30 above.

The annual process

  53.  The auction calendar, set out prior to the start of the year, gives fixed dates for auctions but does not specify which stock will be issued at each auction. Shortly before the beginning of each quarter the DMO will announce the maturity range (and usually the actual stock) to be issued at each of the auctions due in that quarter. The annual process is illustrated in Chart 6, overleaf. The DMO consults the market (both investors and GEMMs separately) prior to each quarterly announcement. The DMO then announce the amount to be auctioned (and the precise stock if not already announced) on the Tuesday in the week preceding the actual auction.

  54.  Although the financing remits are set before the beginning of the financial year, a revised forecast mid-year, usually at the time of the Pre-Budget Report in November, triggers a review of the financing programme. If necessary, the financing arithmetic will be revised in the light of any change in the forecast of the Central Government Net Cash Requirement and any other relevant factors, and Treasury Ministers will amend DMO and NS remits.

  55.  The financing arithmetic for the current year will usually also be revised at the end of the year, with the Budget in March, when the final forecast for the Central Government Net Cash Requirement is made for the year just ending. However at this final stage of the year, most National Savings products and gilts have already been sold and any remaining gilt sales are pre-committed and cannot be changed. This means that the short-term cash management financing instruments have to bear the brunt of the change in the forecast for the net cash requirement, and this temporary financing is usually unwound in the following year's financing plans.

Chart 5



  56.  The agencies, departments and Treasury items which are involved in the management of government debt are all listed in the box overleaf, with a brief summary of the role which each of them plays. This section of the memorandum focuses first on the accounting and reporting arrangements for each part of the debt management operations, and how the accounts interrelate. The end of this section covers how the outputs from the various debt management operations are brought together, consistent with the measurement of the Central Government Net Cash Requirement, and presented within the financing arithmetic (covered in Section 8 above).

Central Funds

  57.  The two key central government funds: the Consolidated Fund and National Loans Fund (NLF) are key to understanding the accounting arrangements for government debt and cash management. Departmental expenditure is authorised by Parliament through Votes (Supply Estimates) and these draw upon the Consolidated Fund. The process of consolidation goes back to Gladstone's reform, which replaced the system of taxes earmarked for specific purposes. The NLF was set up by the National Loans Act of 1968. It became the fund which formally borrowed money for the Government. Thus gilts, National Savings products, Treasury bills and the Ways and Means overdraft are all liabilities of the NLF. Each year the accounts of the Consolidated Fund and the NLF and supporting data in the form of Supplementary Statement are presented to Parliament. The Permanent Secretary to the Treasury, Sir Andrew Turnbull, is the Accounting Officer for both the Consolidated Fund and the NLF.

  58.  The Exchequer Funds and Accounts (EFA) team in the Treasury are responsible for managing the Consolidated Fund and National Loans Fund, and forecasting government cash flows. They report directly to Sir Andrew Turnbull on accounting issues. EFA also have close dealings with National Savings and the DMO, reflecting their responsibility for managing the NLF.

Table 4

Debt and Reserves Management
Treasury team (DRM)Advises Ministers on:
—  debt management policy, plans and organisation:
—  DMO and National Savings remits;
—  publication of Debt Management Report.
Exchequer Funds and Accounts
Treasury team (EFA)Advises Ministers and the Treasury Accounting Officer on:
—  operation of and accounts for Consolidated Fund and NLF;
—  co-ordination of central government banking arrangements;
—  forecasts of cash flows in government bank accounts.
National Savings
An Executive Agency and Government department. Reports directly to Treasury Ministers. Sells National Savings products which contribute to financing the government's net cash requirement.
UK Debt Management Office (DMO)
An Executive Agency of the Treasury.—  Sells and conducts other operations in gilts:
—  oversees the gilts market;
Reports directly to Treasury Ministers, —  deals in government debt for CRND;
and Treasury Accounting Officer;—  cash management;
liaises with DRM.—  accounts for Debt Management Account.
National Investment and Loans Office (NILO) Includes:
Public Works and Loan Board (PWLB), who administer loans to Local Authorities from the NLF;
A separate department under the Chancellor of the Exchequer. Office of HM Paymaster General (OPG), who carry out core responsibility for service delivery of all OPG functions; and
National Debt Office (NDO) who administer accounts, including investment of deposits.
The Bank of EnglandProvides services to DMO for:
—  gilt registration and settlement;
—  back office function for gilts;
—  banking.
Provides services to DRM for:
—  management of UK foreign currency borrowing and Treasury foreign exchange reserves.
Provides banking services and cash monitoring services to EFA and DMO, and banking services to OPG.

  59.  Debt interest (whether for gilts coupons, National Savings products or other forms of borrowing) is a charge on the National Loans Fund[2], with recourse to the Consolidated Fund. The Consolidated Fund reimburses the National Loans Fund for the debt interest it cannot meet from its own interest receipts on its lending, without this being subject to Parliamentary Vote. It is one of the standing services allowed for in legislation.

  60.  Although National Savings products are formally liabilities of the NLF[3], it is a National Savings responsibility to account for the transactions and reconcile their customer records with their liabilities to the NLF. National Savings are required to produce a White Paper account for both the Ordinary Account and the Investment Account, and is now on a voluntary basis planning to produce accounts covering all the other products, following agreement with the NAO. These product accounts are all quite separate from the National Savings Vote, which bears its administrative expenditure but not the debt interest paid.

National Investments and Loans Office

  61.  Some 200 years ago, concerned at the growing size of the national debt, William Pitt established the Commissioners for the Reduction of the National Debt (CRND), who were to reduce debt through the use of sinking funds. The Commissioners have never been abolished and the secretariat to the CRND, called the National Debt Office, is part of the National Investments and Loans Office (NILO). NILO is a separate department under the Chancellor of the Exchequer. However, despite their name the CRND play a relatively minor role in debt management policy and operations. NILO has three functions. It services the Public Works Loans Board which makes loans out of the NLF to local authorities. It runs the Office of HM Paymaster General (OPG) which is responsible for providing banking services to government. (The role of OPG and the privatisation of Paymaster Agency are dealt with in more detail in Annex D.) NILO also acts, through the National Debt Office, as the investment manager for a number of central government (and related) funds which are required to invest deposits in gilts or other government securities rather than on the open market. Whereas most receipts are returned by departments to the Consolidated Fund (apart from appropriations-in-aid) and expenditure out of the Consolidated Fund is authorised through Votes, there are a number of funds where these requirements do not apply. The National Insurance Fund, for instance, receives national insurance contributions and pays out contributory benefits. Its working balances are invested in gilts with NILO acting as investment manager. Similar arrangements for holding deposits are in place for the National Lottery Distribution Fund, court funds, the Insolvency Service and several others. NILO's sale and purchase of gilts for these funds is conducted through the DMO. NILO is permitted to buy some gilts at each auction, but where it cannot get sufficient gilts from these sources it can ask for a special creation of non-market stock to be made from the National Loans Fund. Such "NILO only" stock can only be sold back to the DMO who will if necessary cancel it.

  62.  The other role that NILO had until recently, was to hold the gilt-edged official operations account (GOOA). This account was set up in 1993 to act as a warehousing account for gilts. A combination of the Maastricht Treaty and tax arrangements meant that neither the Treasury nor the Bank of England could hold this warehousing account. So all official transactions in gilts, including primary issuance and any secondary market dealing, was done on this account. A week before any auction, gilts were sold from the NLF to the GOOA and the auction proceeds paid by purchasers into the GOOA. Any secondary market purchases or sales by originally the Bank and then DMO were done on the GOOA account. The head of NILO was the Accounting Officer for the GOOA and the annual accounts were presented to Parliament.

  63.  When the DMO took over responsibilities from the Bank, this enabled the Government to set up a new account to replace the GOOA (tax changes a few years earlier removing the second reason for the establishment of the GOOA). The Finance Act 1998 amended the National Loans Act to provide for the establishment of the Debt Management Account (DMA). This was created by Order on 15 November 1999. The remaining holdings of the GOOA were sold to the DMA and the GOOA has now been closed. Final accounts will be presented to Parliament for its transactions in 1999.

Debt Management Account

  64.  The DMA, however, will not simply take over the gilts transactions previously done on the GOOA. It will also be the account which records the DMO's cash management operations. In future Treasury bills will be issued by the DMO and will become liabilities of the DMA. Any lending by the DMA to the market, in periods when the government has excess cash, will be an asset of the DMA. Clearly, the DMA will have a close relationship with the NLF: sizeable and frequent flows will exist between the two. Essentially the DMA's role is to meet the financing needs of the NLF, both in terms of long-term requirements (debt management) and short-term and day-to-day cash needs (cash management). The Chief Executive of the DMO is the Accounting Officer for the DMA and accounts will be presented to Parliament in the normal way. However, gilts will remain the liabilities of the NLF. The DMA will be involved in primary issuance and occasionally in a small amount of secondary market gilt transactions. The responsibility for paying gilt coupons and redeeming debt on maturity will fall to the NLF, with Registrar's Department of the Bank of England acting as the Treasury's agent.

Bank of England

  65.  The Bank of England still provide the registration and settlement functions to the gilts markets, and banking services to DMO. Bank Registrars also offers a brokerage service for private individuals who wish to buy and sell gilts. This is a service which previously was provided by the National Savings Stock Register (NSSR). In order to reduce costs, the gilts registration system was restructured with effect from July 1998, and the NSSR and Bank Registrars were brought together under the responsibility of the Bank of England.

  66.  Secondary market transactions in gilts normally take place between two private sector parties. The settlement process is provided by the Central Gilts Office, formerly of the Bank of England but now owned by CRESTCo, and due to be merged with the equities settlement system, CREST. The DMO has responsibility to monitor the gilts market, and occasionally this will involve transactions with it, but in the main secondary market gilt transactions take place totally outside Government accounts.

Relationships with Treasury: accountability

  67.  Both National Savings and NILO are separate Government Departments from the Treasury, but ones which report to Treasury Ministers. The Accounting Officer responsibility rests with the heads of those Departments and not with the Accounting Officer for the Treasury. The DMO on the other hand is part of the Treasury. Its administrative expenditure is borne on the Treasury Vote and in legal terms anything which legislation authorises or requires the Treasury to do, may be carried out by the DMO if delegated to it. The Accounting Officer for the Treasury has designated the Chief Executive of the DMO as Agency Accounting Officer for the DMO and has designated him as Accounting Officer for the Debt Management Account.

  68.  As Executive Agencies both the DMO and National Savings follow the standard model involving a framework document, corporate and business plans for setting of Agency targets, quinquennial prior options reviews and annual agency reports and accounts. The key role of both agencies is to help deliver the Government's debt management policy and annual remit, which is set by the Treasury. These arrangements give a common structure to the relationships between the Treasury and both agencies. Treasury Ministers are advised by the Treasury team responsible for Debt and Reserves Management in setting the aims, objectives and the overall framework for both DMO and National Savings. Both agencies supply the Treasury with regular monitoring reports on financing progress. Certain actions need to be approved by the Treasury (Treasury Ministers have to authorise National Savings rates, though in practice these follow very much from the remit). The DMO would have to come to the Treasury if it sought to act in a way which altered the annual remit.

Consolidating the Government cash accounts and determining the net financing requirement

  69.  With several agencies, departments and accounts involved in debt management, it is clearly very important to assemble consolidated accounts to determine the level of net cash financing required. In terms of the formal constitution of the government accounts, government cash flows, including financing, are consolidated and controlled through the two central government accounts, the NLF and the Consolidated Fund. In terms of overall cash accounting, the government accounts are consolidated through the Central Government Net Cash Requirement, which determines the level of net cash financing required.

  70.  The Central Government Net Cash Requirement consolidates cash flows across all government accounts. Since these government accounts are balanced, these cash flows net out to zero. The measure of the central government net cash requirement is produced by classifying these cash flows as determinants, which together determine the level of net cash requirement, or as financing items, which provide the net financing. Reconciliation between the Central Government Net Cash Requirement and the Consolidated Fund and NLF accounts is audited each year by the National Audit Office. The split between determinants and financing items follows international conventions for national accounts statistics, wherever practical given the cash nature of the measure. The concepts of Government Net Borrowing and the Central Government Net Cash Requirement are explained further in the government publication "Monthly Statistics on Public Sector Finances: A Methodological Guide", which also explains the relationship between them.

Treasury monitoring and reporting

  71.  The government presents the annual Debt Management Report to Parliament in March each year. This report on the government's debt portfolio, debt management policy, developments in the gilts market and National Savings, the debt management programme for the current year, and the annual forward plans and remits for the DMO and National Savings. The Government is committed to the principles of transparency and predictability in promulgating its debt management plans and policy, both as required by the Code for Fiscal Stability, and in the context of market efficiency. Transparency in debt issuance plans and policy improves the efficiency of the market, which then produces the best price for government debt.

  72.  The government announces updated financing plans with every published Treasury economic forecast, based on the latest forecast for the Central Government Net Cash Requirement. Tables which show the main financing plans are included in the main budgetary publications. If details of revisions to remits cannot be covered in the budgetary publications then they are announced separately to Parliament, for instance through an answer to a Parliamentary Question. The DMO also announce revisions to remits separately to the market, after these have been announced to the House.

  73.  National Savings and the DMO report monthly to Treasury Ministers on their performance against their remits, and developments in the retail and gilts market, respectively. The DMO also report the outcome of gilt auctions and other gilt management excercises directly the results are known.

  74.  DMO and National Savings also publish various reports aimed at their customers in the market. The DMO, for instance, publish an Annual Gilts review and a quarterly update. However, this is not designed as a report to Parliament, its main audience being the gilts market itself. It tends to be of a rather technical nature.

  75.  Outturn statistics for Central Government Net Borrowing and the Central Government Net Cash Requirement are published by the ONS and Treasury in the monthly document "Public Sector Finances first release". Table 1.2A in the ONS publication "Financial Statistics" gives a breakdown of the monthly statistics for the Central Government Net Cash Requirement by financing instrument.

  76.  National Savings and DMO, as Executive Agencies, are required to produce annual agency reports which are laid before Parliament. These report on their own administrative expenditure, their progress against targets etc. The accounts for the Consolidated Fund and the NLF, and National Savings are presented to Parliament annually. From 2001, the accounts of the Debt Management Account will also be presented to Parliament.

November 1999

1   "Debt Management Theory in Practice" by Donna Leong; Treasury Working Paper No 10; April 1999. This paper is being made available to the Sub-Committee separately. Back

2  Except for the National Savings Ordinary Account deposits which are invested in the National Savings Bank Fund, managed by NILO. Back

3  Except for the National Savings Ordinary Account deposits which are invested in the National Savings Bank Fund, managed by NILO. Back

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