Overview and key points from survey responses Introduction

All sovereign debt managers are subject to operational risk. The scope and scale of operational risks faced by sovereign debt managers vary according to their institutional setting, and with the types and frequency of transactions they undertake. Fundamental differences in these parameters could lead to different perspectives on the relative importance of particular operational risks.

For example, a sovereign debt management agency that does not use many portfolio management techniques after primary issuance will not face the same operational risks as compared to one that has a highly active, transaction intensive approach to portfolio management. Likewise, the level of independence from the central Ministry of Finance, and the extent to which functions are outsourced also influences the range of operational risks to be managed.

As such, while the set of operational risks that any sovereign debt manager faces may be similar, the relative importance of the different risks may vary from sovereign to sovereign.

Key points

Institutional setting and governance arrangements

Over the past decade or so, a number of sovereign debt management agencies have been set up with varying degrees of independence from their central Ministry of Finance, ranging from operating as a section still within the Ministry of Finance, to complete independence. As part of this process, sovereign debt management agencies, in addition to their traditional transaction-based operations, have taken on a range of new responsibilities ranging from implementing a new human resource management framework, developing and managing their IT systems, and reporting to and managing an Advisory Board. In addition, more recently there has been an increased focus in both financial markets and government agencies on issues such as corporate governance, audit and compliance, and business continuity planning. All these changes have implications for the range of operational risks faced by sovereign debt managers, and the relative importance placed on particular operational risks at a given point in time.

Debt transactions

Whereas a number of issues relating to debt transactions such as the use of derivatives will affect the range of operational risks that need to be managed, the major issues currently facing sovereign debt managers in this regard relate more to market risk (and even political risk) as opposed to operational risk issues.

For the six sovereign debt management agencies surveyed, a number of the issues canvassed relating to debt management transactions (including the types of transactions undertaken, comparative frequency and size of different types of transactions, and settlement techniques) were similar. However, in terms of primary debt issuance, there are a range of techniques used, even within the one debt office for different instruments. For example, long-term debt may be issued using a different mechanism than short-term debt.

From the six sovereign debt management agencies surveyed, the most common primary debt issuance mechanisms used are competitive auctions using dealer panels, and reverse inquiry. In two cases, underwriters are also used. One debt management office uses direct dealing with the secondary market, and one debt management office uses uniform price auctions. Moreover, whereas four of the sovereigns surveyed conducted primary issuance activities in-house, whereas the other two used their Central Bank, which would affect the range and level of operational risk exposure.

These responses tend to indicate that for the sovereign debt offices surveyed, there is no “international best practice” for primary debt issuance.

The background to this may be historical (in terms of not wanting to change the technique that the particular market is used to). It may also point to the fact that there are differences between the short-term and long-term debt markets that tend to promote the use of different issuance techniques.

In broad terms, for the sovereign debt managers surveyed, the level of activity in the secondary market (as measured by the value of transactions) is much less (<20 per cent) than the value of primary debt issuance. However, for two sovereigns with high levels of OTC derivative activity, the ratios are around 1:1. This would be expected to be dependent on the scope of the government’s financing requirements. A government achieving budget surpluses could be expected to require less debt issuance, and at the same time, the debt management agency could be expected to be required to undertake an increasing number of secondary market transactions to maintain liquidity in a government bond market that is likely to be decreasing in overall size.

Business continuity

Whilst the terrorist attacks in the United States in 2001 highlighted the importance of managing operational risk, and in particular disaster recovery

planning, the majority of sovereign debt managers surveyed have still to finalise the development of properly functioning business continuity plans, disaster recovery plans, and back-up sites, and little if any budget allocated to these items. However, some of the sovereigns surveyed do have significant arrangements in place to address these issues.

Compliance and audit

All debt management offices surveyed have strong audit systems in place, including internal audit functions as well as being subject to external audit by their government audit office.

The majority of respondents indicated that the percentage of operational budget attributed to audit functions is 1-2 per cent. Another indicated 5 per cent of the operational budget is attributable to audit. Given the increased focus on audit related functions in the international financial markets, it could be expected that more attention will be placed on audit-related functions within sovereign debt management agencies going forward.

Human resources

The debt management agencies surveyed indicated that in general, key personnel departures have proved to be less of a problem than originally feared, but continues to be a very important issue. The average length of service for employees in the six debt management agencies surveyed is 6 years, and ranges between 2.5 and 13 years. (although this figure may be distorted due to the fact that many debt management agencies have only been formed during the past five years). The turnover ratio for staff (calculated as departures per year divided by total staff) for the six respondents averages 12 per cent per year, and ranges between 5 per cent and 22 per cent.

Consultants are used sparingly in the majority of the debt management agencies surveyed. The most common areas they are used in is IT (particularly for defined projects), and for the provision of legal advice. A number of the debt management agencies have used consultants for other short-term projects.

Information technology and systems

As would be expected, IT now constitutes a major portion of agency operational budgets. For the six sovereign debt agencies surveyed, the amount of the agency budget spent on IT (including salaries) averages 21 per cent of operational expenditure and ranges between 13 per cent and 30 per cent.

Five of the six debt offices surveyed have a fully integrated debt management treasury system incorporating front, middle and back office

functions, although in one case, this is still being implemented. For one of the sovereign debt management agencies surveyed, the accounting system that is fully integrated with the Treasury system. Three other sovereigns indicated the accounting system interfaces with the Treasury system.

The following points are suggested as an initial basis for discussion.