Examination of Witnesses (Questions 1-19)
MONDAY 5 FEBRUARY 2001
MR GUS
O'DONNELL, DR
PAUL MILLS
AND MR
IAN PLENDERLEITH
Chairman
1. This afternoon the Committee is the taking
evidence on the National Audit Office's Report on the sale of
part of the United Kingdom gold reserves. We welcome Mr Gus O'Donnell,
Managing Director, Macroeconomic Policy and International Finance
and Head of the Government's Economic Service to the Treasury
and Mr Ian Plenderleith who is responsible for the implementation
of the gold auction and liaison with the gold market. This is
your first appearance, Mr O'Donnell, before us. You are the Accounting
Officer for the Exchange Equalisation Account, you are also responsible
for managing the United Kingdom Reserve Assets, which include
the United Kingdom's Gold Reserve holdings. Can I start by asking
you to introduce any of your colleagues you wish to?
(Mr O'Donnell) Can I introduce Dr Paul
Mills, who is in charge of debt and reserves management.
2. Welcome, Dr Mills. I normally try and give
you some guidance as to which paragraph I am talking to before
we start, so it helps you. Before we start on the detailed report
we might save some time, in terms of our assessment of this, if
you can give us a short summary of the purpose of the policy,
so we know what we are measuring it against.
(Mr O'Donnell) Can I just say, first of all, without
taking too much time, we very much welcome the Report. It has
been very useful. Discussions between ourselves and the NAO have
been very open. We have learned quite a lot in the time that we
have been discussing it. I would like to put that on record. It
has been very useful to us. In the policy of selling gold and
the reinvestment of proceeds, basically what we were looking to
do was to achieve value for money. The purpose of selling the
gold was to diversify the portfolio. It was part of our analysis
of risk measurement. I know this Committee has been involved a
lot in looking at risk measurement throughout the public sector.
Primarily what this is about is a method of reducing the riskiness
of the portfolio of the EEA. We wanted to do it in such as way
as to maximise value for money but transparently, openly and accountably
in ways that it would be clear to you and to the world that we
have performed this function well.
3. What is your test? Is it the value of the
portfolio measured in Sterling, for example, the stability of
that, the magnitude of that? What is the test?
(Mr O'Donnell) The riskiness of the portfolio we measure
by a value at risk calculation. We have sophisticated ways of
looking at the overall riskiness of our portfolio, which looks
at the kind of maximum loss one might have under certain circumstances.
If you like, Ian Plenderleith could go into detail.
4. We will press on, we will start off with
simple things first. My first material question relates to paragraph
2.7, Figure 10 and Figure 12. I want to start with a reference
to Professor Binmore's argument in Appendix 3, that the announcement
to sell gold could be expected to lead to a fall in the price
of gold. The sharpness of the fall took place (that is referred
to in the paragraphs I mentioned) and the modest amount compared
to other countries' sales (shown in Figure 10) suggest that there
was a significant overreaction, resulting in poor prices in the
first two auctions (that is very apparent in Figure 12). What
did you do wrong?
(Mr O'Donnell) I do not think we did anything wrong.
The issue is whether we should have pre-announced our sales or
not. If we had not pre-announced and we had tried to sell covertly
in the market then it would have become apparent very quickly
that we were selling covertly. I think that would have led to
worries that we were going to sell all of our gold reserves potentially
and I think that could have created even greater price responses.
Even with hindsight the idea of pre-announcing is the right one.
The practicalities of selling covertly are also a big problem
for us because (a) I do not think it would have kept secret in
the market and (b) even if it had for a short time our commitment
to the IMF guidelines means that within a month, under their rules,
we would have to explain precisely what we were doing. Given our
strong commitment to obeying the IMF rules we would have had to
announce, when we put out our usual press release, what had been
happening to reserves and that we had been selling gold.
5. This Committee is normally very much in favour
of transparency, it is one of its reference points, but there
are limits, particularly in your Department where you have to
be wary of transparency with currency operations, for example,
levels of currency, and so on. You would be only too aware of
that. This is an area where, if I am right in reading this Report,
we appear to be the most transparent of the OECD countries in
their approach to gold sales. Is that correct? Is that, perhaps,
taking transparency a touch too far?
(Mr O'Donnell) I think it is fair to say that we have
been at the forefront internationally in getting the IMF to explain
transparency and to develop guidelines and to make things clear.
We are certainly one of the world leaders in transparency, I make
no bones about that. Indeed, in terms of ensuring that we keep
that reputation it was important when we did sell gold that we
were seen to do so in a very transparent way.
6. Let me pursue that a little in respect of
paragraph 21, which tells us that the price of gold rose by 25
per cent within two weeks of the second United Kingdom gold auction
taking place, mainly because of the announcement by European central
banks to limit their future gold sales. If you had not been boxed-in
by an announcement to sell a certain amount at a particular time,
would you not have been able to take advantage of the significant
strengthening of the gold price at that time to achieve better
proceeds?
(Mr O'Donnell) I do not think that would have been
an appropriate response. Say we had cancelled that auction because
we were running up to this potential agreement, which we were
very strongly in favour of and which the Bank very successfully
negotiated, then I think there would have been all sorts of questions
about why had we cancelled that auction. What did we know that
the market did not know. If in raising those sorts of issues we
had at any point put in danger the actual agreement that the Bank
managed to negotiate on limiting and announcing official gold
sales then I think it would have been in the long-term very detrimental
to our interests.
7. Others may want to pursue that, I will not
delay over that now, the whole question of the mixture of high
transparency and relatively fixed or inflexible timetables that
may have an effect on it. Can I move on to another subject, paragraph
2.15 and 2.16, and Figure 16 in particular. I understand that
statistically valid conclusions are not available and that judgment
is needed in interpreting the auction results. Those paragraphs
and the figure I have already mentioned suggest that you may have
achieved better proceeds if you used the so-called Gold Fix—it
is a terrible name for a process—how can you be satisfied
the auction method maximises proceeds?
(Mr O'Donnell) I agree with you about the name. I
think the Fix is a perfectly good way of selling gold, I make
that absolutely clear. It has been used in the markets for a long
time and it is operating perfectly well. It is a perfectly viable
alternative for us. The issue for us was, was there anything which
achieved our objectives better than the Fix? The Fix, it seems
to me, is a perfectly reasonable way of selling gold. In terms
of auctions, what they do for us is they achieve a price we can
measure, which can be clear and when we look at the auction price
and we can compare it with the Fix and that gives us one of the
benchmarks we use. It has the advantage of opening up the process
to a very large number of potential buyers. It is more open and
more transparent, in our view, than the Fix. Whereas the Fix has
a certain number of members, when it comes to auctions, that bidding
is open to a much wider number of potential purchasers.
8. Do you think that gave you better value,
the Treasury better value?
(Mr O'Donnell) It certainly did not give us any worse
value. You can work out the calculations in different ways. If
you compare the afternoon Fix prices with the prices we have,
if you look at auction days only the auctions were slightly better.
All of the numbers are very, very close and essentially statistically
insignificant. There is really very little difference in terms
of value for money in that respect, but where the auction gains
it is in terms of transparency.
9. My next question relates to paragraph 2.22
to 2.26. They discuss the capital and revenue implications of
the gold sales and show that the impact varies as the value of
currencies and interest rates go up and down. Paragraph 2.26 shows
a small gain as at 18th December 2000 but implies that on other
occasions the calculations would have shown a loss. How do you
view the prospect of losing money because of the sales?
(Mr O'Donnell) That is a prospect that we have to
face up to because that particular calculation will move round
with the values of exchange rates, the gold price, et cetera and
it will fluctuate quite a bit. What we have done is taken a medium-term
view that a portfolio which previously had 44 per cent of our
net reserves all in gold, that it is a lot less risky portfolio
if we reduce that number closer to 20 per cent. You should look
at these things over the long or medium term. In a sense, the
NAO pushed us to make that calculation, which we were happy to
do, and it showed a profit, to the point at which the NAO report
was published of $34 million. If you were to re-do that calculation
today you would get a different number.
10. Appendix 4 gives international comparisons
and shows that most other countries have taken a more flexible
approach to their sales than the United Kingdom. In the light
of your experience so far do you see merit in having the ability
to be more flexible in your approach to selling gold in future?
(Mr O'Donnell) Flexibility comes at a cost. In terms
of the market that you see, if you take a more flexible approach
they regard that as you having an option and you will only exercise
that option when it is beneficial to you, the seller, not them,
the purchaser.
11. You are the outlier, in the sense that most
other countries are more flexible?
(Mr O'Donnell) I agree. This relates to our decision
to be more transparent. We probably value predictability more
than some others. We take the view that we want to prepare markets
for this. We want them to know. Auctions in the gold market are
relatively new. We started off relatively inflexible and have
become more flexible, in a sense that we used to announce two
auctions in advance but now we announce only one auction in advance.
(Mr Plenderleith) Can I just add on that, in terms
of the international experience that you refer to, I think the
picture is fairly mixed, it is a difficult assessment to make
because one does not have hard data about other central banks
and what prices they sold at. If you look at the figures that
the NAO have very helpfully got together in the appendix, the
two most comparable cases are Canada, which did show a small gain
against the Fix over the period of its sales, and Belgium, which
showed a rather larger loss. If you look at some of the others
which are less comparable they come out either side of the calculation.
12. Why did you pick those two as comparables?
(Mr Plenderleith) In terms of the size of the sale.
13. That brings me to a question for you before
we widen things out, paragraph 24 tells us that there is wide
support in the London gold market for using the Gold Fix and the
majority of market participants consider this method of sale to
be fair and less disruptive to the market. That is rather relative
to what Mr O'Donnell has just been saying. Would not the use of
the London Gold Fix have the advantage over auctions by being
more flexible, less disruptive to the market and less likely to
destabilise prices because there would not be a focus for adverse
sentiment in the way there is with auctions?
(Mr Plenderleith) I agree very much with what Mr O'Donnell
said, that the Fix is a perfectly viable alternative. It is an
established part of the market mechanism and has worked well for
the market, although not for the large amount of sales such as
we have. We have to space those over time. In terms of the return
one would expect to get, the price one would expect to achieve,
the track record to date suggests that there is very little difference
at all between selling small amounts in the Fix and selling in
the staged auctions.
14. The point Mr O'Donnell was making was a
preference for market stability. The primary argument, as far
as I can see, of market participants here is that they would prefer
the Fix because they think it is more stable and less disruptive
to the market.
(Mr Plenderleith) The preference is for smaller amounts
to be sold each day in the Fix. In terms of the price one would
achieve, the track record is that it makes very little difference,
although I think the comparison is not entirely fair because if
we had been selling each day on the Fix the Fix price would have
been lower. Where the Fix less closely meets the Government's
objectives is that it is plainly open directly to fewer players,
in other words less generally open, and it is less transparent
in its process because the figures are not published daily.
15. Can I finish before I widen things out with
a final question for you Mr O'Donnell. I see from your letter
of 26 January that you are reviewing the auction process including
consideration of suggestions and recommendations in the C&AG's
Report. What conclusions have you come to?
(Mr O'Donnell) We are indeed conducting that review.
At the moment that is with the Bank which is doing a review of
market participants and the like, and we are looking at the success
we have had in those auctions so far. The idea is that we will
have completed that review in order to come to views about the
next financial year onwards about how to do the sales process.
It is in progress. That review will take account of all the points
raised in the NAO Report so I hope we will learn from that process.
The kinds of issues we are looking at are precisely the ones that
have come up here, like how much information can one provide for
the markets and how much information do the markets want about
auctions afterwards—there are differences of view there—and
issues about auctions versus the Fix and the like. We are actively
considering all of these points.
Chairman: I will just point out for the record
that I have got this far without one reference to a system for
winning at roulette. Mr Edward Leigh?
Mr Leigh
16. If we were to join the euro would we have
to pass our gold reserves over to the Central Bank in Frankfurt?
(Mr O'Donnell) The European Central Bank? There is
a system whereby a certain proportion of our reserves are allocated
across to the European Central Bank. My understanding is that
we retain ownership of those.
(Dr Mills) Yes, there is a pool that the European
Central Bank has allocated to it and each member central bank
puts into the pot their share according to a pre-announced key
at pre-agreed ratios.
17. What sort of proportion of their gold reserves
do they put into the Central Bank?
(Dr Mills) I think the ECB guidelines are that 15
per cent of reserves put into the pool are to be gold. In our
case if we were to go in I think we are talking about $1 billion-worth.
18. We will put in $1 billion. Is the selling
of gold and buying of euros in any way related to the Government's
desire to join the euro?
(Mr O'Donnell) No. The whole purpose of selling gold
is simply portfolio diversification to reduce the riskiness of
our overall portfolio.
19. Is it right that 40 per cent of the revenue
from the gold sales was invested in euros?
(Mr O'Donnell) The proceeds of selling the euros are
allocated across our foreign exchange reserves in exactly the
proportions we set them up. Our foreign exchange reserves are
held 40 per cent dollars, 40 per cent euros, 20 per cent yen.
Every dollar we get from selling gold we allocate 40 per cent
dollars: 40 per cent euros: 20 per cent yen. The overall composition
of our foreign exchange reserves is completely unaffected by gold
sales.
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