13 Portugal1

International Monetary Fund
Published Date:
August 2003
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As a result of Portugal’s entry into the European Economic and Monetary Union (EMU), the environment underlying the management of the Portuguese government debt has gone through very important changes in the last few years. By adopting the euro as its currency, the country now benefits from both the credibility of a monetary policy that is defined at the level of the European Union (EU) and the fiscal discipline that EU members have to comply with. Furthermore, the constraints on government debt management resulting from the execution of the monetary policy have been greatly diminished with EU membership, because Portugal has gained access to a much larger “domestic” financial market—the euro debt market. The challenge the country faces with this new position is the loss of being the reference issuer of the Portuguese escudo and becoming a small borrower in a large market, where one has to compete with other sovereign issuers for the same base of investors.

In the second half of the 1990s, and in anticipation of these changes, a series of important reforms took place that aimed to develop conditions for a more efficient management of public debt in this new environment. These reforms included, at the institutional level, the creation of an autonomous debt agency, the Instituto de Gestão do Credito Publico ([IGCP] Portuguese Government Debt Agency), in 1996; the publication of a new Public Debt Law approved by parliament in 1998, and government approval of formal guidelines for debt management in 1999.

Developing a Sound Governance and Institutional Framework

Debt management objectives

The strategic objectives to be pursued in government debt management and state financing were made explicit by the new Public Debt Law, which states that these activities should aim to guarantee the financial resources required for the execution of the state budget and be conducted in such a way as to

  • minimize the direct and indirect cost of public debt in a long-term perspective,
  • guarantee a balanced distribution of debt costs through the several annual budgets,
  • prevent an excessive temporal concentration of redemptions,
  • avoid excessive risks, and
  • promote an efficient and balanced functioning of financial markets.

Minimizing the cost of debt was already an implicit objective of debt management before the approval of the new Public Debt Law. Nevertheless, its enactment has been an important step in that it has formalized these objectives, clarifying the issue of the minimization of cost so that it would be pursued in a long-term perspective and introducing an explicit reference to risk limitation, that is, how to reduce refinancing risk and the volatility of debt cost over time.

The objective of promoting an efficient and balanced functioning of the domestic financial market was particularly important before the creation of the EMU, in a context where most of the debt was denominated in escudos and placed on the domestic market. The relevance of creating and maintaining a benchmark yield curve to support the escudo capital market vanished as the escudo was integrated into the euro.

The guidelines for debt management, approved by the minister of finance in late 1998 and in force since 1999, adopted a model for risk management and translated the strategic objective of minimizing debt costs into the definition of a benchmark that, since then, has been the reference point for debt management. The risk management approach has four basic components:

  • adoption of a consistent model for the development of primary and secondary markets for Portuguese public debt;
  • development and implementation of clear debt management guidelines and risk/performance evaluation (benchmark);
  • investment in information technology (IT) systems to support well-informed management decisions, reduce operational risk, and increase transparency by improving availability and quality of all transaction data; and
  • development and implementation of a comprehensive manual of operational procedures to reduce operational risk and support external and internal auditing.

The scope of debt management activity

Debt management includes the issuing of debt instruments, the execution of repo transactions, and the completion of other financial transactions with the purpose of adjusting the structure of the debt portfolio.

There is no limitation in the Public Debt Law as to the nature of the financing instruments that can be used for funding. However, concerns about the liquidity of the government debt led to a progressive concentration of the financing activity into the issuance of a restricted number of standard fixed-rate treasury bonds (obrigações do tesouro [OTs]) and euro commercial paper (ECP). The issuance of savings certificates, a retail instrument sold to individuals on a continuous basis, remains an important funding source.

As a facility of last resort, repo transactions are made available to market makers. The objective is to support the market-making obligations of the primary dealers in the secondary market of the OTs. Repos are provided in a range of amounts for each security. Taking into account market conditions, the price is fixed at a rate below the average posted euro overnight interest rate (euro overnight index average [EONIA]).

To adjust the redemption profile of the government debt, the Public Debt Law includes the early redemption and buyback of existing debt and the direct exchange of securities within the scope of operations allowed to debt managers. Since 2001, this practice has also been used more intensively for the purpose of promoting liquidity in the treasury bond market through the concentration of existing debt into larger and more liquid issues.

The Public Debt Law also includes within the scope of debt management the trading of derivatives, namely interest rate and currency swaps, forwards, futures, and options. Those transactions must be linked to the underlying instrument in the debt portfolio. Swaps and foreign currency forwards have been the instruments most used for this purpose.

Although contingent liabilities are not now taken into account in debt management decisions, it is planned to analyze them in the future with a view to including them in the risk management framework. The debt agency, IGCP, is responsible only for the management of the direct public debt of the central government, even though it is required to appraise the financial terms of guaranteed debt and debt issued by (public sector) services and funds with administrative and financial autonomy.2 Within the ministry of finance, the treasury department follows, quantifies, and reports explicit contingent liabilities in a systematic way.

For the time being, the scope of the IGCP’s activity does not include the investment of surpluses that may exist in the state central cash accounts, which are also under the responsibility of the treasury department.3 The permanent exchange of information on policies and forecasted treasury flows between the two entities is carried out to coordinate funding and surplus investment effectively.

Legal framework

The main legal framework that regulates the issuance of central government debt and the management of public debt includes

  • the Public Debt Law, which states that state financing has to be authorized by parliament;
  • the annual Budget Law, which establishes limits for the amounts that the government is authorized to borrow during the year in terms of net borrowing (The annual Budget Law may also define maximum terms for the debt to be issued and limits to the currency exposure and to the floating rate debt.); and
  • the decree-law that regulates the activity of the IGCP.

According to the legal framework, the IGCP’s responsibility is to negotiate and execute all financial transactions related to the issuing of central government debt and the management of the debt. The minister of finance is empowered to define specific guidelines to be followed by the IGCP in the execution of the financing policy.

Permanent guidelines from the minister of finance were formalized through the adoption of a long-term benchmark structure for the composition of the debt portfolio. The benchmark reflects selected targets concerning the duration, interest rate risk, currency risk, and refinancing risk and sets the reference for the evaluation of the cost and performance of the actual debt portfolio.

The government approves annually, through a council of ministers resolution, the debt instruments that should to be used in state financing for the year and their respective gross borrowing limits. The minister of finance annually approves specific guidelines for the IGCP. The guidelines include broad lines for the management of the debt portfolio (e.g., buyback of debt and repo transactions) and the issuing strategy in terms of instruments, maturities, timing, and placement procedures. The guidelines also cover measures to be implemented regarding the marketing of the debt and the relationship with the primary dealers and other financial intermediaries. These guidelines are made public.


Previously, two departments inside the ministry of finance were in charge of central government debt management. The treasury department was responsible for the external debt and the issuance of treasury bills, and the public credit department was responsible for domestic debt (excluding treasury bills). Since 1997, operational activities associated with central government debt management, including the servicing of the debt, have been centralized in the IGCP. The IGCP is empowered to negotiate and carry out all financial transactions related to the issuing of central government debt and the active management of the debt portfolio, in compliance with the guidelines approved by the minister of finance.

The IGCP is organized to allow the flexible use of its resources, namely with recourse to project teams. The organizational structure comprises the board of directors, two departments, and five technical and four operational units, with a total staff of 65 people.

The agency is governed by a board of three directors, appointed by the council of ministers for a term of three years. The board reports to the minister of finance. An advisory board, composed of the chairman of the board of directors, a member of the central bank’s board of directors, and four experts in economic and financial matters, appointed by the council of ministers, provides recommendations on strategic matters.

The debt management department is responsible for all the aspects related to the definition of issuing and portfolio management policies, follow-up of the secondary market, relationships with the primary dealers and other financial intermediaries, negotiation and placement of nonretail debt, and active management of trading. The department comprises two units, the trading room and a markets unit.

The operations department is responsible for matters related to the confirmation and settlement of the wholesale transactions executed by the trading room, debt accounting, and procedures related to withholding tax on the debt interest. The department is also responsible for the issuance and amortization of savings certificates and the debt service of other retail instruments. The operations department is in charge of the post office, which acts as an agent for the selling and redemption of savings certificates. It includes three operational units, a documentation and settlements unit, a debt accounting and budgeting unit, and a retail debt unit.

Four other units report directly to the board of directors:

  • the financial control unit, which is responsible for all aspects related to risk and performance evaluation, internal control, procedures definition, and internal auditing;
  • the research and statistics unit, which produces economic analysis, definition of scenarios, and external reporting;
  • the IT systems unit; and
  • the administration unit, which is in charge of all internal matters, including personnel, acquisitions, and on-site premises.

A markets committee meets weekly to analyze market developments, treasury forecasts, and the position of the debt portfolio against the benchmark and define guidelines for the activity during the week. The committee includes the directors and heads of the debt department, operations department, financial control unit, research and statistics unit, trading room, and markets unit.

There has been a strong concern with transparency since the IGCP began to operate in 1997. Key functions are now covered by written internal procedures, which include delegation of powers and the role of each unit inside the organizational structure.

A detailed quarterly report is submitted to the minister of finance, which describes all the transactions executed during the period and presents the figures for cost and risk of the debt portfolio relative to the benchmark. A report describing the activities carried out throughout the year and presenting the financial accounts of the debt is published annually.

To allow the IGCP to hire and retain qualified staff, some aspects were legally provided for, including a high degree of administrative and financial autonomy within an annual budget approved by the minister of finance and the possibility of hiring personnel under the general labor law, that is, not as civil servants. The guidelines for personnel compensation—approved by the minister of finance—are based on the need to maintain competence in competition with the private banking sector. Budgeting was also adequate in providing the financial resources necessary to acquire and update the information systems.


An audit committee is responsible for following up and controlling the financial management of the IGCP as well as supervising its accounting procedures. The audit committee is composed of a chairman nominated by the inspectorate-general of finances and two permanent members (one being an official chartered accountant) appointed by the minister of finance.

The audit court (public sector audit body) is responsible for overseeing the activity of the IGCP, covering the financial accounts of the debt and the compliance with the guidelines and limits established by parliament and the government. This audit has been recently extended to the internal procedures and to the quarterly report presented to the minister of finance.

Risk Management Framework

Main risk variables

Since the inception of the IGCP, a significant effort was made to formulate and, whenever possible, quantify the types of risk relevant to public debt management.4

The main priority for the IGCP is to guarantee the fulfillment of Portugal’s yearly borrowing requirements. To minimize the risk of not being able to meet this requirement, the focus has been on two key areas—first, the development of an efficient market for the public debt and, second, smoothing the redemption profile of the debt portfolio.

Consequently, a high priority was given to the minimization of refinancing risk5 in spite of the comfort derived from the depth and liquidity of the euro capital market. The constraints imposed at this level are increasingly important, given the market’s constant demand for liquid bonds, basically meaning large outstanding volumes. The reconciliation between these two conflicting requirements has been partially achieved by investing both on the efficiency of the primary and secondary markets (basically trying to compensate lack of size with extra efficiency) and on the set-up of other methods of managing the redemption profile (besides issuance), namely buy-back programs. Subject to that, the debt manager has the overall objective to minimize the long-term cost of debt without incurring any excessive risks. In this context, the IGCP assessed the major risk for a public debt manager as being the extent to which the volatility of financial variables affects the budgets’ volatility (through changes in debt-servicing costs), thus reducing the range of maneuvering of the fiscal policymaker. Therefore, in management of the debt, risk is more accurately measured on a cash-flow basis, in contrast to a value-at-risk basis commonly used by asset managers. As a result and like several other public debt managers, the IGCP is working on the development and implementation of an integrated budget-at-risk (BaR) indicator for the debt portfolio.

Until the process to implement the BaR model is finished and tested, cash-flow risk is measured through a combination of indicators, namely duration, refixing profile,6 and currency exposure. Duration works as a proxy for the degree of cash-flow cost immunization to interest rate movements and has the advantage of being a standard market measure. To give a more comprehensive picture of total interest rate risk, the duration indicator is complemented with the refixing profile. Since 1999 and the introduction of the euro, the foreign exchange risk, measured as the percentage of the portfolio denominated in foreign currency, has been significantly reduced, so that now it is almost negligible.

In a pure liability management framework,7 only the use of derivatives causes credit risk. Derivatives are used when the desired portfolio structure is impossible to obtain, for whatever reason, through funding transactions. The IGCP measures this type of risk with an adapted version of the Bank of Internal Settlement (BIS) model,8 and controls it through tight procedures for counter-party approval, including credit scoring, limits attribution, and International Swap Dealers Association (ISDA) agreement negotiation. The use of collateral as a means of partially covering credit risk has been approved by the minister of finance and was implemented during 2002.

Finally, the IGCP incurs operational risk in its debt management activities. This last type of risk is not measured explicitly, but underlies several policy measures. It was first addressed when the IGCP was created, leading to the choice of an organizational structure based on the financial industry standard of front, middle, and back offices with clearly segregated functions and responsibilities. The operational risk has since been a focus of attention by means of three main initiatives: a significant investment in IT (e.g., the purchase of a management information system), followed by the development of a manual of internal operating procedures, and finally investment in qualified and experienced human resources. In the future, these measures will be complemented with internal auditing, besides the external auditing that is already done by the audit court.

Management guidelines and benchmark portfolio

The debt portfolio management mandate given by the minister of finance to the IGCP was further formalized in 1998 with the approval of management guidelines and a reference portfolio in the form of a benchmark.

The management guidelines aim to describe the main types of risks associated with the debt portfolio, specify whether they are measured on an absolute (e.g., refinancing and credit risk) or a relative9 basis (cash-flow risk), and, where appropriate, impose limits on the risk variables. The maximum divergence that the debt portfolio can show relative to the benchmark for the relevant risk variables (i.e., the maximum level of additional risk the debt manager can take) is also established in the guidelines.

The main purpose behind the adoption of a benchmark by the IGCP was to have a measurable reference of the long-term target portfolio structure, based on the conviction that this type of guidance would improve consistency between day-to-day debt management decisions and long-term goals. Furthermore, the fact that the IGCP was created as an independent entity raised the need for a tool that allowed an objective evaluation of management results (accountability). This influenced the decision to adopt the benchmark as well for performance measurement purposes.

No standard exists for how to establish and follow a benchmark for public debt management. The IGCP’s approach is to create a management instrument, which incorporates the governments’ preference concerning the trade-off between short- and long-term risks and costs. The benchmark is therefore deemed to incorporate the long-term objectives of the portfolio owner—that is, the minister of finance, acting on behalf of the tax payers in terms of risk profile and expected level of cost—embodied in a financing strategy and the resulting portfolio structure.

The determination of this benchmark portfolio was based on a mixed simulation-optimization model, in which the key decision variables were cash-flow cost and risk, with a restriction to address explicitly refinancing risk (other risk components were analyzed for every possible solution, but no limits were imposed on them in the model). A short list was then made of the model’s solutions, not only in terms of efficiency, but also in terms of robustness to the model’s main assumptions (macroeconomic and interest rate scenarios).10 The final choice of a solution among the subset of efficient and robust possibilities was determined by the conjunction of three factors:

  • The trade-off between cash-flow risk and costs: The shape of the efficient frontier given by the model showed a clear reduction in cash-flow risk for portfolio durations of up to 2–2.5 years, justifying the increase in expected cost. For durations longer than 3.5–4 years, the marginal decrease in cash-flow risk was low, compared with the expected increase in cost. This analysis led to the choice of a first subgroup of possible solutions.
  • Comparison of the resulting risk figures (especially interest rate risk) with the equivalent values for other euro-area sovereigns: Consideration of the relevant framework in which fiscal policy operates in Portugal, namely the existence of the stability pact and of a single monetary policy, led to the conviction that the Portuguese debt portfolio should not take on excessive relative interest rate risks when compared to the other sovereigns in the euro area. A survey done at that time on the durations of the public debt portfolios in other countries showed durations varying between three and five years. Based on this, it was then decided that the benchmark portfolio should have an expected duration close to the three-to-four years range.
  • Finally, the financing strategy associated with each possible solution was analyzed, because the funding strategy associated with the benchmark portfolio had to be a feasible strategy for a euro-area sovereign issuer.

These factors ended up determining the choice of the portfolio that should be taken as a benchmark for the debt management at the IGCP and associated financing strategy.

Formally, the management guidelines approved by the minister of finance are divided into five sections, containing

  • a list of relevant definitions (of scope and risk/cost variables),
  • the set of authorized instruments and transactions,
  • limits for the key risk variables (namely refinancing profile, modified duration, refixing profile, and currency exposure) and reporting requirements (timing and content),
  • composition and dynamics of the benchmark portfolio, and
  • credit risk.

Of these, the first three were published. The theoretical model behind the definition of the benchmark was also published in the IGCP’s Annual Report 1999, even though the approved benchmark portfolio is not publicly disclosed (neither are the credit risk guidelines).

To use the benchmark as a fair basis for performance measurement, conditions that allow a separation of funding and market development decisions from portfolio management decisions must be in place. For Portugal, this possibility came about in 1999, with the first stage of the EMU. Since then, the euro capital market became the relevant “domestic” market, in which Portugal is a sufficiently small player for its derivatives transactions to have no major impact and subject to no other interpretation from market participants than pure portfolio management decisions.

In this type of framework, debt management decisions performed through the combination of financing and derivative transactions aim at a certain relative positioning versus this benchmark, in terms of both interest rate and foreign exchange risk, expected by the debt managers to outperform the benchmark. However, when the benchmark model was first developed and analyzed, it was done with a strong emphasis on the strategic objectives, meaning that the main purpose of that reference portfolio was to improve the consistency between the day-to-day management decisions and the long-term portfolio goals. For reasons of accountability, the IGCP decided to also propose its use for evaluation purposes, and this led naturally to the expectation of outperformance. However, there is no formal or informal policy statement (from either the minister of finance or the IGCP) transforming that expectation into a debt management objective, as such.

The benchmarking process in the IGCP had an experimental year in 1999 and has since been in place formally. Even though the overall assessment of its usefulness is positive, it has to be said that it is, in a liability management context, a less straightforward process than asset management, for several reasons. First, not only is it very difficult to quantify all the restrictions and objectives of a sovereign debt manager, but also these change in time, which leads to either the nonduplicability of the benchmark (i.e. the possibility to replicate the benchmark, making it unfair as a performance measurement tool) or to the need to make frequent changes in the benchmark itself, a situation that goes against the desired nature of such a tool.

Another specific problem is that, even in a small player–big market situation like Portugal’s in the euro market, the funding policy adopted by the IGCP has an influence on the credit spreads of Portuguese government bonds, which, however, is very difficult to quantify. This circumstance makes it even harder to estimate the cost levels associated with different funding policies (e.g., the cost of the benchmark-simulated financing strategy), turning the operational maintenance of that reference portfolio into a relatively complex exercise.

The IGCP is continuously improving the model for determining the benchmark portfolio and the methodology for its implementation. However, the project is still in an early phase, and the benchmark has therefore not been made public. In addition, the disclosure of the benchmark may be negative for the debt manager, because it may allow the market to anticipate its position. This problem could occur when the debt manager is asking for quotes on derivatives, such as interest rate swaps. This is a risk that should be analyzed carefully, even in the context of the large euro market. This question will be reassessed during the next revision of the guidelines (including the benchmark), which is scheduled for the end of 2002.

Finally, a performance benchmark in sovereign liability management should always be taken with a high degree of pragmatism and discernment by both the portfolio manager and the portfolio owner (in this case, the government).

Management information systems

At the end of 1999, the IGCP bought a standard treasury system11 to support its debt management transactions. The choice of a user-friendly front, middle, and back office–integrated system12 was made not only to mitigate operational risk, but also because of the conviction that, by increasing the use and share of information across the IGCP, it would lead to better data quality. Having one robust database of all debt transactions was one of the selection process’s main priorities. The system was initially developed and designed for corporations, thus it had a strong cash-flow focus with a good fit to the risk management policy at the IGCP.

Moreover, a system was developed to handle retail debt transactions, which are then registered monthly in the new treasury system only in aggregate form for position-keeping, accounting, and reporting purposes.

Operational procedures manual

The implementation of these two systems had a considerable impact on the internal processes at the IGCP, increasing the need for the development of a written manual of operating procedures, including the new tools for operational control. This is an ambitious project, which started in 2001 with aims not only to optimize the internal processing circuits at the IGCP, but also and in that process, to develop a new culture regarding operational risk matters and associated control procedures (including internal auditing).

Debt Management Strategy and Government Securities Markets

Debt management strategy

Portuguese debt management follows a market-oriented funding strategy. It acknowledges the importance of issuing marketable instruments at market prices and building up a government yield curve with liquid bonds along different maturities. The new euro environment did not change this target. However, this goal now exists in a different environment. The former role of developing a benchmark yield curve to support the development of the domestic capital market disappeared. Instead, the new competitive environment in the euro area has been driving the funding strategy. A much larger domestic market, where the 12 euro countries compete, replaced the protected Portuguese escudo market. As a consequence, the market participants require higher liquidity and more efficient markets.

Liquidity became, in fact, one of the most important factors behind the spreads displayed by sovereign debt in the euro area. An outstanding amount of no less than 5 billion is commonly accepted as a first criterion of liquidity. Therefore, the target size for Portuguese treasury bonds was increased to this new threshold.13 Because of the relatively low level of the Portuguese gross annual borrowing needs, a gradual approach to achieving this goal has been followed. Since 1999, every year, priority is given, first, to the introduction of a new 10-year issue and, second, to a new 5-year issue. These two maturities, backed by an efficient derivatives market, reflect the market’s preference. In support of this strategy, most of the funding through marketable instruments has been channeled to the euro-denominated treasury bond market. To accelerate this strategy, since 2001, the IGCP has also been relying on an active buyback program aimed at refinancing old issues (with small outstanding sizes and coupons not in line with current market yields) with on-the-run issues.

Feeding liquidity into the OTs market14 reduced the variety of instruments used to standard and “plain-vanilla” fixed-rate bonds. The issuance of floating-rate bonds has been suspended, and index-linked securities have been ruled out so far. Moreover, in the meantime, the access to the Eurobond market, which was regular before 1999, has been excluded. A global medium-term notes program, in place since 1994, now plays the role of a safety-net funding alternative, with no new issue placed after September 1999.

Although not always cost-efficient in a short-term perspective, the priority given to the issuance of medium- and long-term bonds, putting aside “opportunistic” funding alternatives, is conceived as a medium-term strategy to reduce country vulnerability. Simultaneously, priority has been given to the development of efficient primary and secondary treasury debt markets, making use of advanced technical infrastructures. Foreign and domestic financial intermediaries and final investors were all granted equal access to these markets. This strategy is being rewarded by the increasingly widespread geographic distribution of the OT in the euro area and by its dispersion between buy-and-hold investors and active traders.

Government securities issuance and primary market structure

Credibility is a decisive feature whenever a market-driven funding strategy is followed. Transparency and predictability are, therefore, important pillars of Portuguese debt management.

The strategic guidelines are regularly explained to market participants, financial intermediaries, and, in particular, institutional investors.

At the beginning of the year, the components of the annual funding program are publicly announced, with particular emphasis on the issuance of medium-and long-term tradable debt securities. The market is informed of the estimate of the annual gross borrowing requirements and the amount to be funded through the issuance of Portuguese treasury bonds (OTs). The amounts to be placed, the maturity and final size of the new lines, the mechanisms for placing the OT (syndication and auction), and the financial intermediaries to be involved are also announced. A more precise calendar is published quarterly. The auctions have been kept fixed at the second Wednesday of each month, whenever there is room for such a placement.

About 75–80 percent of the gross borrowing requirements are funded through the placement of OTs.15 Short-term market instruments and nontradable debt (savings certificates), issued on demand from private investors, account for the remaining 20 percent. The issuance of ECP is a backup alternative supporting the implementation of the treasury bond program.

For liquidity reasons, the initial size of a new treasury bond line corresponds to about 40 percent of the targeted final amount. Therefore, the IGCP is using syndication when launching a new OT line. This option aims to achieve better control of the issue price and, at the same time, further diversify the investors’ base. The preference given to the placement of the initial tranche through syndication is due to the belief that it is the most effective way to simultaneously achieve significant size (more than 10 times the indicative amount of auctions held in 1998) and efficient and controlled pricing. Moreover, it helps to achieve a wide and diversified investors’ distribution, particularly within the euro area, and increases the visibility of the issuer’s name and its debt instruments.

Furthermore, a syndicated structure makes it possible to target specific groups of investors and countries. The IGCP has been closely monitoring the book-building process in all syndicated issues, demanding the investors’ identity disclosure from the underwriters. New syndicated structures have been developed, giving increasing importance to the book-building process. More recently, the pot system was studied and has been used. In the pot system, all orders are centralized and collected to a single order book shared by the joint lead banks in the syndicate, in contrast to traditional syndication, in which the joint lead banks are managing separate order books. This gives the IGCP possibility of allocating the distribution after certain desired targets for the investor base are reached. The fees to the banks are set in advance and are not affected by the final distribution.

Only the primary dealers (13 banks) can be invited to be underwriters of the syndicated issues. This is a privilege that not only rewards their commitment to the OT market, but also recognizes that they are the financial intermediaries who know best the OT base of investors.

After the initial OT tranche is issued through syndication, the amount is increased through auctions.16 Multiple-price electronic auctions are normally conducted once a month (but not every month). In 2000, the technical support for the auctions was radically changed. The fax system previously used for bidding was replaced by an electronic system, the Bloomberg Auction System. This system allows the auction participants to introduce and update bids until the cutoff time (strictly controlled) and have faster access to auction results, thus incurring fewer risks. The possibility of monitoring the reception of bids in real time enables the issuer to reduce the time needed for a decision on the allotment of each auction. Currently, the average time from the bid cutoff time to the release of the auction results to the participants is less than five minutes.17

The settlement of primary market transactions is carried out through efficient and internationally recognized central securities depository (Euroclear and Clearstream), making the fulfillment of standard settlement cycles possible for both domestic and foreign investors.

Secondary market for government securities

The development of an efficient primary market for treasury bonds has to be supported by an efficient secondary market. In 1999, a special market for public debt was created, the MEDIP (the Portuguese acronym for “special market for public debt”), which was designed to be a regulated market under the investment services directive. To ensure an efficient and competitive environment, an electronic trading platform (MTS-Portugal) was chosen, based on the MTS platform.18 After the creation of MEDIP, three segments coexist in the secondary market:

  • the exchange market, whose trading structure is mainly directed at the retail segment and the trading of small lots (this segment is traded in the Euronext Lisbon), and participants are those who have access to this market;
  • the over-the-counter market, which should offer maximum flexibility in terms of trading and registration of transactions; and
  • MEDIP, which aims to centralize wholesale trading by offering the most efficient conditions for this type of transaction where the most important players are the primary dealers.

The creation of MEDIP and the adoption of electronic trading were decisions that fostered financial integration while preserving the national “location” of the wholesale treasury debt market. The setting-up of MEDIP–MTS-Portugal therefore marked an important and decisive step in the modernization of the Portuguese government debt market, a step promoting its efficient integration into the euro financial market and the vast global market. This step, taken by the issuer and the primary dealers together, was the culminating point of a strategy that took almost three years to unfold. This ongoing dialogue, acknowledging the critical role of the primary dealers in developing the secondary market, was an outstanding feature of this process, which led to the selection of the best electronic trading platform to be used.

As a regulated market, MEDIP’s access and listing conditions, its governing rules, and its code of conduct are nondiscriminatory and subject to the approval of the Portuguese Securities Market Commission. This market aims at wholesale proprietary trading among specialists. It uses a blind trading platform based on the electronic platform MTS-Telemático, managed by MTS-Portugal (which is a joint-stock company incorporated under Portuguese law and supervised by the Portuguese Securities Market Commission).19

The MEDIP market is driven by market-making obligations, and it settles with Euroclear/Clearstream and has access to repo trading facilities in EuroMTS/MTS-Italy. Real-time prices are disclosed to nonparticipants on the Reuters wire, and a daily market bulletin is published via the Internet. The market makers have the obligation to quote firm bid and ask prices for a set of liquid securities according to maximum spreads—ranging between 5 and 10 basis points, depending of type of security and maturity—and minimum lot sizes. The market dealers can only take prices from market makers. The primary dealers must participate as market makers, and other participants can act either as market makers or market dealers. Prices formed on MEDIP are used as a reference for mark-to-market purposes.

The primary dealers’ strategic role

Portuguese debt management relies on the critical role of the primary dealers. The primary dealer system was introduced in Portugal in 1993, but only in 1998 did the role of the primary dealers gain a new strategic dimension. By then, new selection rules had been defined to limit the participation of each major domestic banking group to only one institution, thus inducing the development of critical mass on domestic operators. Also in 1998, this status was first granted to nonresident banks. After 1999, the primary dealers were defined as the principal channel for distributing Portuguese debt, and a network for the regular distribution of debt within the euro area was created.

Primary dealer status is granted for periods coinciding with calendar years and may be renewed annually, depending on the fulfillment of several duties. To be granted primary dealer status, a bank has to fulfill a certain group of obligations vis-à-vis the market and the issuer,20 namely minimum quotas in the primary and secondary markets have to be attained. Besides being invited to be underwriters of syndicated issues, primary dealers are also granted exclusive access to noncompetitive auctions.21 The increasingly important direct contact between the issuer and final investors is also conducted in cooperation with the primary dealers.

Counting on a credible and relatively stable group of primary dealers, with a recognized distribution capability (both within the euro area and worldwide) and committed in the long run to the development of the Portuguese debt market, the IGCP established an ongoing partnership for the continuous distribution of the Portuguese debt and for creating a liquid and efficient wholesale secondary market.


The case study was prepared by Rita Granger, Lucia Leitao, and Vasco Pereira from the Instituto de Gestão do Credito Publico ([IGCP], Portuguese Government Debt Agency).


Above a certain threshold, set yearly.


The decree-law that created the IGCP recognized the importance of further integration of treasury management and debt management. Formal integration is under consideration.


For that purpose, all the learning processes associated with the modeling of a benchmark portfolio made a critical contribution, making that project, as such, a worthwhile investment.


For instance, such risk involves not being able to roll over the maturing debt close to previous market prices or, in the extreme, at any price.


The refixing profile indicates, in nominal terms, the percentage of the portfolio that will either be refixed or have to be refinanced in the future, aggregated in yearly time buckets. It aims to indicate the sensitivity of cash-flow cost to future changes in interest rates.


Not considering the cash management function or the “credit” component of settlement risk.


In this model, the credit risk is assessed by calculating the current market value of the contract and then adding a factor to reflect the potential future exposure over the remaining life of the contract.


Measured as a deviation from the benchmark portfolio equivalent figures.


Given the context in which Portuguese debt management is performed, this reference portfolio was built so as not to have any net foreign exchange risk.


Finance Kit by Trema


This was done at the loss of a more specialized risk management software.


The a5 billion standard corresponds to almost twice the average size of the treasury bond lines issued before 1999.


Since 1999, the final size of each new OT line has on average been twice that of those issued up to that date.


The features of the OTs have been kept stable, and the conventions used are in line with the standards of the euro debt market.


The 1999 auctions were already three times larger than the previous ones; in 2000, the average size increased fivefold, and when compared with 1998 and between 1998 and 2001, the increase was sixfold.


Portuguese OT auctions include a competitive phase (in which participation is open to all primary dealers and other auction participants) as well as a noncompetitive phase. Before every quarter, the IGCP releases a calendar of the auctions, although the indicative amount of the auctions is confirmed only slightly before it takes place. A predefined day of the month tends to be used. Each institution can make up to five bids, whose total value may never exceed the amount announced for the competitive phase of the auction. Participating institutions are informed of the bids that were accepted and of the overall results immediately after the close of the auction (on average, two to three minutes after the cutoff time). The overall results of the auction are also immediately announced to all market participants via the IGCP pages in Reuters (IGCP04) and Bloomberg (IGCP). The subscription for the noncompetitive phase of the auction is made at the highest yield accepted in the competitive phase. The maximum amount each primary dealer can subscribe in the noncompetitive phase corresponds to the percentage of its participation in the competitive phase of the previous three bond auctions, considering only the amount placed through primary dealers.


The platform became active in July 2000.


Shareholders in MTS-Portugal are the IGCP, 15 percent; MTS S.p.A., 15 percent; and primary dealers, 70 percent.


Duties of primary dealers:

  • participate actively in bond auctions by bidding and subscribing a share no less than 2 percent of the amount placed at the competitive phase of the auctions;
  • participate actively on the secondary market for Portuguese government debt securities, ensuring the liquidity of these instruments;
  • participate in the wholesale electronic market (MEDIP–MTS-Portugal) as market maker, maintaining a share not lower than 2 percent of this market’s turnover in the previous two years;
  • participate as shareholder in the managing company of MEDIP–MTS-Portugal; and
  • operate as privileged consultant to the issuer in the monitoring of financial markets.

Rights of the primary dealers:

  • participation in the competitive phase of the bond auctions and exclusive access to the noncompetitive phase;
  • preference in the formation of syndicates;
  • access to the facilities created by the IGCP to support the market, namely the “last resort” repo window facility;
  • preferential counterpart in the active management of the public debt; and
  • privileged hearing in matters of common interest.


Another group of banks can also have access to the auctions—the other market participants—but they are not allowed to participate in the noncompetitive auctions.

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