Outright purchases of foreign currency bonds swapped into fixed rate sterling

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Outright purchases of foreign currency bonds
swapped into fixed rate sterling Graham
Young Bank of England
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Seminar Plan
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Changes to the Banks operations

• Banks tender system Btender was launched for
  OMO repo operations in November 2007.
• Bank began outright purchases of gilts using
  Btender in January 2008.
• Final phase of the project is the outright
  purchase of foreign currency bonds, swapped into
  fixed rate sterling, in competitive tenders.

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Why purchase bonds ?

• Asset-liability management the value of
  banknotes in issue fluctuates during the year but
  has a large permanent element.
• Operational efficiency less churn of shorter
  maturity repo assets.
• Buying foreign currency bonds too to mitigate
  impact on gilt market.
• But in the form of synthetic gilts.

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Principles

• Five principles to guide the investment strategy
  for the portfolio-
• Simple and transparent
• Non-discretionary
• Minimal credit risk
• In line with behavioural maturity of Issues
  liabilities, ie banknotes
• Not disruptive of HMG debt management policy

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Investment Strategy

• Buy-and-hold in routine circumstances
• AAA, domestic-currency issues only
• Conventional issues only
• gt4bn in issue and gt2 of total universe
• Currently means we will buy bonds issued by the
  US, Canada, Germany, France, Austria, Spain,
  Netherlands and Denmark
• Maturity distribution will target that of gilts
  in issue, maximum maturity of 20 years

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Asset Swap Tenders
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Asset swap tender structure (i)

• Bank is purchasing an asset swap package so
  Participants express offers in terms of a
  synthetic sterling yield
• No limit on size or number of offers across
  Btender
• Par-Par swap structure
• Swap terms governed by a new pro-forma ISDA
  master agreement CSA separate bilateral
  meetings arranged on that

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Asset swap tender structure (ii)

• Single issuer tender for US, Germany and France
• Smaller issuers combined one tender for
  Austria, Netherlands and Spain other for Canada
  and Denmark
• Bank will offer to buy two bonds within each of
  three segments of the curve (so six in total).
• Fixed quantities to be purchased in each segment
• Where bonds are of similar maturity from same
  issuer
• Bank will set minimum/maximum quantities to be
  purchased (/- 25) and apply
• Relative value using its fair value curve

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Asset swap tender structure (iii)

• Monthly except August and December.
• On the Wednesday following publication of MPC
  minutes.
• 2.15-2.45pm.
• Tender size no more than 450mn in single
  issuer tender, 600mn multiple issuer tender.
• Exchange rate fixed using 2.00pm RBS fixing
• Unlike gilt tenders, will not exclude
  Cheapest-to-Deliver bond and open issues.

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Announcement schedule

• Annually
• Aggregate expected size of bond purchases during
  the forthcoming calendar year
• Quarterly
• Size of tenders during the quarter
• Foreign currency issuers to be purchased
• Monthly (one week ahead of tenders)
• Details of the specific bonds for purchase

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Btender Overview and Demonstration Mike Jones
and Tarkus Frost Bank of England
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System overview

• Able to view operation details as available
• Counterparty specific plausibility limits can be
  set pre-tender
• Offers submitted by entering
• Foreign currency nominal of the bond (which will
  be converted to sterling using the fixed exchange
  rate)
• Sterling yield
• Individual results revealed when operation
  outcome posted on wire services
• Historical results available for up to one year

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System Overview - Access

• Access in place desktop or stand-alone
• Btender uses SWIFT accreditation details, not a
  separate log-on/password
• Level of identification your decision
• Start by logging onto Browse

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System Overview - Access(2)

• Once session open, select browsing menu and then
  Btender system
• Can set Btender as default on log-in

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Btender Demonstration
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Btender - Demonstration

• Interactive demonstration available after this
  talk
• Also happy to answer any questions

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Settlement Processes Andrew Grice Bank of England
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Settlement asset swap

• All asset swap confirmations will be sourced from
  Btender.
• . we will not accept counterpart asset swap
  confirmations.
• Settlement instruction changes must be
  pre-notified 48 hours prior to the tender
• Settlement will be T3 except for US Treasuries,
  which will be T1

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Settlement asset swap

• We will net off the foreign currency principal
  flows arising from the asset swap
• . so the Bank will deliver sterling, following
  the receipt of the FC bond on a free of payment
  basis.
• But before paying away sterling, all ISDA credit
  exposures must be collateralised.
• Bonds to be delivered to Euroclear (EUR / DKK),
  FRBNY (USD), Bank of Canada (CAD).
• Spanish Gov Bonds to be delivered to an account
  with Bank of Spain (domestically).

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Collateral Management

• Asset swap exposures will be collateralised on a
  net basis with any other transaction exposures
  under the ISDA
• Daily re-margaining
• Calls from counterparties to the Bank must be
  made by 9.30 the call notification time. 
• The Bank will act as Valuation Agent for ISDA
  exposures there is no dispute mechanism
• Securities must be delivered for same day
  settlement by 3pm.

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Collateral Management

• Bank reserves the right to call throughout the
  day
• Call before midday same day settlement.
• Call after midday next day settlement by 11am

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Collateral Management

• Collateral will be securities only.
• In contingency, we will accept US cash this
  must be pre-agreed with the Bank
• and it may be unremunerated.
• Eligible collateral the same as for SMF repo
  OMOs.US Treasuries and Canadian Government bonds
  are contingency collateral if pre-agreed

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Settlement Collateral Management

• Bonds can be delivered to CCBM accounts, CREST,
  FRBNY or BoC depending on issuer and currency
• In the case of Austrian, Belgian, Dutch, French,
  German, Irish and Italian domestic bonds,
  collateral can be delivered to Euroclear
• International (XS) bond to either ICSD
• but only from ICSD accounts.

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Matrix of collateral settlement locations
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Settlement ongoing payments

• The Bank will only release its foreign currency
  payment when
• the coupon on the FC bond originally sold has
  been confirmed as paid to our account and
• the sterling interest payment on the swap has
  been received.
• If these conditions are not met, the payment will
  not be made, and use of funds will not be
  provided.

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Next Steps Mike Jones Bank of England
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IT Requirements

• SWIFTNet connectivity in place and confirmed to
  the Bank by mid August
• Trial for training and familiarisation
• Live for operations
• Any SWIFT issues, use usual internal and external
  channels
• Any issues with the Btender application, contact
  the Bank

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Training (25 August 5 September)

• Chance for you/your traders to learn from us how
  the system works and ask any questions about the
  tender process.
• Interactive Btender sessions at your office or
  the Bank.
• Small groups, can be tailored to attendees.
• Contact Mike Jones to arrange a session.

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Familiarisation (8 26 September)

• It is compulsory for you/your traders to practise
  using the system and get to know how the Bank is
  going to conduct tenders.
• Chance to see how Btender will fit in with your
  internal processes.
• 3 Scripted and 5 unscripted tests to cover a
  range of functionality and scenarios. Scripts
  will be provided, including expected results.
• Reduced number of scripted and more unscripted
  reflects repo/gilt feedback.
• Contact any member of the team with questions.

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Dress rehearsal (Post familiarisation period)

• To prove the whole process involved in an asset
  swap tender, including settlement and
  collateralisation of swap exposures.
• Script will be provided. Timing will be key so
  please follow the script carefully.
• Run over test systems, including Euroclear.
• Contact Andy Moorhouse with questions. More
  details to follow.

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Documentation

• Btender User Guide will be updated in August.
• Asset swap operations already covered in
  Operating Procedures. Any final changes in
  advance of go-live will be circulated before the
  end of September.
• A revised ISDA is required this should be
  signed by mid-September. Separate meetings are
  being held to discuss.

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Go-live schedule

• Subject to a successful familiarisation period,
  we will look to go live in Q4 2008.
• Specific go-live dates will be announced after
  the dress rehearsal.
• We will request sign off (on a pro forma) that
  you are ready operationally following training,
  familiarisation and dress rehearsal.

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Questions?
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Contact details

• Graham Young (Chief Manager, Sterling Markets
  Division)
• ? 020 7601 3181 ? graham.young_at_bankofengland.co.
  uk
• Mike Jones (Project Manager, Electronic Tender
  System)
• ? 020 7601 4375 ? michael.jones_at_bankofengland.co
  .uk
• Andy Moorhouse (Analyst, Sterling Markets
  Division)
• ? 020 7601 4069 ? andrew.moorhouse_at_bankofengland
  .co.uk
• Andrew Grice (Manager, Settlement and Custody)
• ? 020 7601 3581 ? andrew.grice_at_bankofengland.co.
  uk
• Website page http//www.bankofengland.co.uk/marke
  ts/money/omo/outright_purchases.htm