The UK’s Debt Management Office has defended one of its main ways of financing the government’s spending after a senior parliamentarian questioned whether it was harming taxpayers.
The DMO primarily issues bonds to keep the UK government funded through regularly-scheduled auctions, which are supplemented with more bespoke “syndications” arranged through a club of big banks known as primary dealers.
It is the latter process that Mel Stride, a Conservative MP that chairs Parliament’s Treasury select committee, highlighted in a public letter earlier this month, questioning whether the pricing of over £300bn of gilts sold through syndications since 2009 had been “keen enough in favour of the taxpayer”.
Sir Robert Stheeman, who has led the DMO since 2003, has replied that the mix between syndications and auctions “reflects our judgment on the most effective way of delivering the financing requirements as a whole”, and defended syndications as an important part in the DMO’s toolkit — especially at times of financial stress.
“Whilst the outcome of each individual operation must clearly be judged in terms of value for money for the taxpayer, the programme as a whole must also be resilient to exogenous shocks,” Sir Robert wrote in a letter released on Monday. “The syndication programme has demonstrated, both during the financial crisis and subsequently, that it can assist with mitigating the consequences of such exogenous shocks.”
Syndications can make more sense at times of turbulence or extremely large borrowing needs because at auctions, primary dealers commit to buying and “warehousing” the gilts sold until they can offload them to investors, which absorbs some of their financial capacity for a period. Syndications can also be used tactically outside of the regular auction calendar, the DMO pointed out.
Mr Stride had highlighted how the size of syndication order books corralled by banks often outstrips the amount of gilts being sold — at the latest one, investors placed orders of almost £50bn for £6.5bn of gilts — and queried whether this meant they could be sold at an even lower interest rate.
The DMO said that demand for gilts sold through syndications appears to have been artificially padded by many investors putting in bigger orders than they in reality want, to ensure that they get at least some allocations.
“This behaviour, which has been observed across government bond syndications internationally, can result in sizeable but potentially misleading order books and therefore should not be taken as an indicator of the level of demand,” Sir Robert wrote.
All 58 of gilt auctions held since 2011 had priced at the lower end of the “price guidance” set ahead of syndication by banks in conjunction with the DMO — in other words at a lower interest rate than initially indicated.
Mr Stride had also questioned whether investors and banks might have an incentive to shun gilts which new government bond sales are priced off, artificially lowering their price ahead of the syndication and therefore lift the effective interest rate the government pays.
The DMO stressed that its mandate did not include market supervision, but said that it closely monitors how gilts trade around syndications, and pointed out that if this was occurring one would see the price of benchmark gilts diverge from the rest of the UK government bond market, falling ahead of the sale and rising afterwards.
Instead, since the beginning of 2009 the average gap between benchmark gilts and their closest neighbours has actually narrowed slightly the day before a syndication, and on syndication day itself, the DMO noted.
The DMO revealed that it had paid $599m to banks to help arrange syndications since the programme was restarted in the wake of the financial crisis, or about 0.18 per cent of the amount raised. However, Sir Robert stressed that these fees in practice helped subsidise banks’ broader gilt market support, such as their continuing commitment to buying gilts through the regular auctions.
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