- International Monetary Fund
- Published Date:
- August 2003
Developing a Sound Governance and Institutional Framework
The main objective of debt management is to ensure that financing needs are met with a low funding cost in a long-term perspective, within a sustainable path, and with a prudent level of risk. The risks considered are refinancing, market, credit, operational, and legal.
Scope of debt management activities
Debt management covers both internal and external debt. In addition to funding, debt management also includes management of outstanding debt and contingent liabilities, the latter especially related to infrastructure and public credit operations.
Coordination with monetary and fiscal policies
The 1991 Constitution states that Banco de la República (BdR), the central bank, will be the independent agent responsible for monetary and foreign exchange policy, and the ministry of finance will be responsible for fiscal policy. The DMO, Dirección General de Crédito Público (Directorate General of Public Credit), is situated within the ministry.
Issues that require coordination with the BdR regarding monetary policy, debt management, and the macroeconomic agenda are discussed in the regular biweekly meetings of the board of the central bank, of which the minister of finance is member. The BdR is also in charge of the settlement and clearing of the domestic debt market, which involves coordination between fiscal and monetary authorities in the management of the domestic public debt.
Two officials from the BdR are also members of the Debt Advisory Committee, which determined the guidelines for debt management and the debt issuing program.
The legal framework for debt management is included in Decree 2681 of 1993, which covers
- Public credit transactions that involve new funding and, therefore, increasing the debt stock.
- Debt management transactions that reduce portfolio risk and do not increase debt stock. These transactions include hedging operations such as cross-currency swaps, interest rate swaps, debt exchanges, refinancing, debt conversions, and the like.
As mentioned, the ministry of finance is responsible for debt management, and the DMO (Dirección General de Crédito Público) is a division of the ministry. The ministry of Finance has six divisions:
- Superior (minister, deputy ministers, general secretary),
- Macroeconomic Policy Division,
- National Treasury (Tesoro Nacional),
- Budget Division,
- Subnational Governments Division, and
- Dirección General de Crédito Público.
The DMO is in charge of debt management, and the National Treasury is in charge of cash and asset management. Coordination and communication with the treasury is essential. Although the DMO works closely with the treasury to create synergies between the two areas, communication could be vastly improved by merging these two divisions. No doubt, this merger would also improve ALM. However, at present, there are no plans for a merger.
Management of internal operations
The DMO adopted a new internal structure in May 2001, following recommendations from the World Bank. The new structure, including responsibilities, is the following:
- front office—local and external funding,
- middle office—analysis of portfolio risks and strategy, and
- back office—operational issues.
Besides these three sections, the DMO also includes the legal affairs office and the IT office.
The new structure improves communication and coordination among front, middle, and back offices, thereby reducing operational risk. Completion of a document describing the DMO procedures has also reduced operational risk.
Debt management decisions and actions must be based on accurate and updated information about the debt portfolio. To improve databases and analysis tools, DMFAS software from the United Nations Conference on Trade and Development (UNCTAD)2 is currently in the process of being implemented. This software is especially designed to strengthen the technical capacity to record, manage, and analyze external and internal debt. It also provides facilities for the recording and monitoring of bond issues, on-lending, and private nonguaranteed debt. After the software is adjusted for the Colombian requirements, it is expected to
- reduce operational risks,
- simplify procedures,
- produce debt profiles and financial risk quantification in real time,
- improve capacity to evaluate statistical models,
- be compatible with other information systems,
- increase accuracy of exercises,
- allow Internet operability, and
- provide a proactive alarm system, which will alert management if the portfolio reaches any debt management policy limits, such as the stated currency or interest rate composition of the debt.
Staff members receive continual training, allowing them to acquire important market skills, while helping the DMO attract and retain qualified staff. This is particularly true in the middle office, where staff receive ongoing training in portfolio analysis and strategy. Individuals are often attracted to this benefit of acquiring knowledge in these areas, thus making the DMO a good working environment. This is especially important because salaries in the public sector often are not competitive with those in the private sector.
A benchmark for external debt has been established since 1997. Although there is no legal obligation or economic incentive that will ensure that debt management is implemented prudently, historically the benchmarks have been met. Internal debt benchmarks have not been formally adopted; however, according to present plans, the authorities approved a benchmark for the internal debt in June 2002.
Transparency of the debt figures is achieved through the yearly report of the ministry of finance. This report includes a summary of the previous year’s agenda as well as the state of the economy and debt portfolio. Two web sites are also available for debt figures, www.minhacienda.gov.co and www.coinvertir.org.co.
Debt Management Strategy and Risk Management Framework
Reducing the country’s vulnerability
During the mid- and late 1990s, the main concern was minimizing the exposure of the external debt portfolio to market shocks and international crisis. As a consequence of this concern, the Public Debt Advisory Committee (Comité Asesor de Deuda Pública) was created on April 21, 1997, integrated by officials from the ministry of finance and the BdR. The main objectives of the committee are to analyze and discuss guidelines for the internal and external indebtedness and propose risk management guidelines.
In 1997, the ratio of internal debt to external debt was approximately the same as it is today. In contrast to the external debt, the internal debt was considered as carrying less risk, because it was made up mainly of liabilities with the public sector. Therefore, the main concern was minimizing the exposure of the external debt portfolio to market shocks and international crisis. As a consequence, benchmarks for the external public debt were established as reference points for the central government and for the eight public entities with the highest outstanding external debt. The benchmarks cover refinance risk, interest rate risk, currency risk, and duration and have been an important tool in controlling and minimizing the exposure to external shocks. The amortization profile has never exceeded the 15 percent limit a year, considerably reducing refinancing risk, and the portfolio has met the currency and interest rate composition in the benchmarks, thereby minimizing market risk.
Because the characteristics of the domestic capital market are different from those of the international capital market, it is not possible to use the external debt benchmark for the internal debt portfolio. For management of the internal debt portfolio, risk management guidelines have been taken into consideration but no explicit benchmark has been adopted. However, the Public Debt Advisory Committee approved a benchmark for the internal debt in June 2002.
Main risks in the government’s domestic and foreign debt portfolio
To reduce vulnerability, the DMO focuses on refinancing and market risks. The benchmark for the share of internal debt is 67 percent and 33 percent for external debt.
Since 1997, the Public Debt Advisory Committee has established benchmarks for external debt. These benchmarks have been updated yearly and were reviewed in May 2002. The benchmarks for the external debt are
- Refinancing: No more than 15 percent of the total external debt can mature in any given year. The ideal is 10 percent. (The rationale behind these figures is that market conditions may require executing a funding strategy that exceeds the 10 percent limit, but never the 15 percent limit.)
- Currency composition: U.S. dollar, 83 percent; euro, 13 percent; and yen, 4 percent.
- Interest rate composition: fixed and semifixed rate ≥ 70 percent, floating rate ≤ 30 percent.
- Modified duration: 3.5 years.
For the internal debt, the following benchmarks were approved at the meeting of the Public Debt Advisory Committee in June 2002. The new benchmarks will guarantee that future funding programs will be in line with debt guidelines. The benchmarks for the domestic debt are
- Refinancing: No more than 20 percent of the total internal debt can mature in any given year. The ideal is 15 percent.
- Fixed and price-indexed: Colombian peso, fixed, 92–96 percent; price-indexed, 4–8 percent.
- Interest rate composition: Because local debt instruments are either fixed, price-indexed, or U.S. dollar–indexed, there is no interest rate benchmark for the internal debt.
Two methods are used to quantify the portfolio risk. The first method compares the actual portfolio with the benchmarks. The second method, called debt-service-at-risk (DsaR), is currently used. DsaR allows the DMO to quantify the maximum debt-service cost of the debt portfolio with 95 percent likelihood. The methodology takes into consideration the exposure to different market variables, such as interest rates, exchange rates, and commodity prices. For managing the cost and risk dimensions of the debt portfolio, the middle office presents a monthly report of funding alternatives based on DsaR analysis. This report compares the cost of the expected scenario with the risk scenario of the different funding alternatives.
The funding strategy takes the benchmarks into consideration. The front office analyzes the market situation and different funding alternatives. If the funding strategy requires exceeding one or more limits established in the benchmarks, the possibility of a hedging transaction is analyzed.
To have access to financial markets, control over both refinancing and market risk is essential. As previously mentioned, since 1997, the amortization profile of external debt has never exceeded the 15 percent limit, considerably reducing refinancing risk. Recent crises in Russia, Brazil, Turkey, and Argentina have emphasized the importance of monitoring these two risks.
Refinancing in advance, when the conditions of the external capital markets are favorable, has been a successful strategy. It allows the ministry of finance to guarantee the funding needs at a low cost, while anticipating future market shocks. The view of the market is a combination of judgments of parameters such as political conditions, falling spreads, tighter yields, and investors’ demand for bonds, in addition to various bank surveys.
For domestic debt, it is important to remember that the local market for public debt is only five years old. Moreover, investors are only progressively demanding longer-term instruments. The first issues were securities with one-, two-, and three-year maturities. Therefore, the amortization profile historically showed concentrations in the first and second years. Now, when the daily volume traded has increased considerably and inflation has reached one-digit levels, fixed-rate securities with longer maturities (5, 7, and 10 years) have been successfully introduced. Securities with longer-term maturities (10 and 15 years) are price indexed.
Several voluntary debt swaps have also been executed recently:
- In June 2001, an internal voluntary debt swap was conducted. Short-term (2001–05) amortizations were reduced by US$2.4 billion, and the refinancing risk was reduced considerably.
- In January and March 2002, two internal voluntary debt swaps took place. US$512 million of short-and mid-term amortizations of U.S. dollar–denominated TES were exchanged for 10-year tenor, fixed-rate peso-denominated TES, considerably reducing exchange rate and refinancing risk.
- In May 2002, another voluntary swap took place, exchanging US$589 million of external bonds (euro- and U.S. dollar–denominated) maturing between 2002 and 2005 for 10-year TES maturing in 2012.
- In June 2002, an external voluntary debt swap was executed. External bond short-term (2002–05) amortizations were reduced by US$255 million, considerably reducing refinancing risk.
- Other small internal debt exchanges are held regularly.
So far, the Colombia has issued eight bonds with options, two of which have already been exercised (a “knock-out” yen option and a put option). Management of the risks associated with these options has been conservative. For budgetary purposes, all bonds with put options are always registered as if all the investors exercised the option. This allows the republic to have funds on hand to cover the option.
Strategies to generate returns
The DMO does not engage in active debt management strategies. Transactions such as interest rate and currency swaps have only a hedging purpose. However, by following interest and currency rates, transactions that could reduce debt service are considered if favorable market opportunities occur.
Management of contingent liabilities
The DMO middle office is responsible for explicit contingent liabilities. The responsibilities of the DMO are to verify the methodologies used by the public entities that generate these liabilities. With these models, the DMO structures a contributed payment plan to create a fund, which will be managed by a fiduciary. This fund allows having liquidity to pay the liabilities when the contingency occurs.
In addition, the DMO operates by
- implementing and developing methodologies for quantifying contingent liabilities on guarantees offered by the government to private agents in concession projects of state-owned infrastructure (highways, electricity generation, water, and communications),
- developing methodologies for quantifying contingent liabilities in public credit transactions (guarantees of the central government on external or internal debt of municipal governments and public entities), and
- creating methodologies for credit risk analysis of municipal public entities.
The procedure of contingent liabilities management includes appointments with investment banks and public entities, developing simulation models for risk assessment, and developing a schedule for the contingent liabilities payouts (including the probability of payouts).
Management information systems used to assess and monitor risk
The IT office created a database that has been in use since 1997. This software allows inquiries about the current debt portfolio; however, it does not have a risk-monitoring module. For risk quantification, the middle office uses its own models based on Excel spreadsheets.
As previously described, more sophisticated DMFAS software will be implemented in 2003. A team is currently working on the transition process. Besides allowing for the possibility for consultation of debt information, the new software will provide analysis of the exposure of the debt portfolio to volatility in interest rates and exchange rates and have the capacity to make simulations of new funding strategies.
Development in markets for private sector debt
The DMO has been one of the most important agents involved in the development of the local capital markets. The treasury bond market has become a model for private debt issuers. This means that the private sector takes into account all developments in the public debt market.
Developing the Markets for Government Securities
Development of the primary market
The DMO is the only agency that issues central government debt. The central bank no longer issues bonds for monetary policy purposes. The DMO is also responsible for updating the database of the public debt, which includes debt of the central government plus other public institutions and subnational governments.
The profile of the internal debt portfolio has changed since 1997. Today, 76 percent of the internal portfolio consists of treasury bonds and notes (exposed to market risks), compared with more than 90 percent five years ago. In 1997, 34 percent of outstanding treasury bonds and notes were liabilities with private investors; today, the ratio has increased to 40 percent.
The DMO issues 1- to 10-year fixed-rate instruments, and 5-, 7-, and 10-year instruments are issued as price-indexed securities. U.S. dollar–indexed securities in 2-, 3-, 5-, and 8-year maturities are issued only when the exchange rate of the Colombian peso to the U.S. dollar undergoes periods of considerable volatility or those that are not part of the normal funding program. To diversify the debt stock across the yield curve, the DMO considers the amortization profile, market conditions, funding cost, and bond liquidity when deciding on the issuing plan.
Treasury securities in the domestic market are issued by two mechanisms. In 2002, weekly primary Dutch auctions counted for 40 percent of internal funding. The remaining 60 percent of internal funding in 2002 was covered by direct placement to public entities. Direct placements (mandatory and agreed-upon) are made with public entities that have cash surpluses. These public entities are price takers in the market.
In the international market, bonds are issued in the U.S. dollar, euro, and yen markets. Borrowing is also executed by loans from multilateral credit agencies and syndicates, as well as other commercial loans.
The ministry of finance issues official press releases with information on bond (local and external) placements as well as agreed loans. These releases are available on the web site, www.minhacienda.gov.co.
Development of the secondary market
Since 1997, one of the objectives of the DMO has been the development of the local public debt market. For this purpose it has established the Programa de Creadores de Deuda Pública (Public Debt Market Maker Program). In this program, 24 of the most important financial institutions, of which 22 are private and 2 are public, participate in weekly primary auctions of treasury bills, notes, and bonds.
Contacts with the financial community
Communication between the DMO and the financial institutions is regarded as very important. Meetings between representatives of the financial institutions and officials from the DMO take place at least every quarter. In the local market, there is constant communication with financial institutions, members of the market maker program, and important investors such as pension funds, fiduciary funds, and insurance companies. For the external market, it is important to keep close contact with various financial institutions that provide market feedback, promote trading of instruments, and have direct contact with key investors.
Clearing and settlement
The following systems are used to settle and clear local debt market transactions:
- DCV (Depósito Central de Valores), the electronic central depository that handles all of the public local debt;
- SEN (Sistema Electrónico de Negociación de Deuda Pública), the system that handles the electronic local public debt market; and
- SEBRA (Sistema Electrónico de Banco de la República), the electronic settlement system used for primary auctions for public local debt.
Tax treatment of government securities
Government securities are tax free only for the profits on the principal of stripped securities. Nonstripped government securities have the same tax treatment as corporate securities.
The case study was prepared by Gustavo Navia, Jorge Cardona, and Carlos Eduardo León, from the Directorate General of Public Credit of the Ministry of Finance and Public Credit.
UNCTAD is the principal organ of the United Nations General Assembly to deal with trade, investment, and development issues.