Transcript of Question & Answer Session Panel Participation at the ASIC Annual Forum on ‘Wholesale Market Conditions and Resilience'

All right, we might kick off. I think we’ve got most people in and sitting down, a few more might trickle through as we go along. Good afternoon, everyone. You’ve done well to make it through to the end of the day, for those of you who have been here all day, and thanks for joining us for this session on ‘Wholesale market conditions and resilience’. You may be wondering where Greg Yanco is. You’re right, I don’t look like a Greg. Unfortunately, he’s fallen ill, so I’m stepping in for him today to moderate this session. My name is Calissa Aldridge. I head up our Market Supervision team at ASIC. We oversee trading or exchange and over-the-counter markets and also supervise market intermediaries.

I’d like to start by acknowledging the traditional custodians of the lands on which we meet today, the Gadigal People of the Eora Nation, and pay my respect to their elders past and present. I’m delighted today to be joined by such an esteemed panel: Michael Bath, Nell Hutton and Dr Jonathan Kearns. Michael is the Acting CEO and Head of Global Markets and Business Strategy at the AOFM, the Australian Office of Financial Management, responsible for issuing and managing Australian Government Securities. Michael led the establishment of the Securitisation Fund and Structured Finance Support Fund, which have proved to be critical during market stress in supporting the market, and Michael is recognised for this work in the Queen’s Birthday Honours List, which is a great testament to his contribution to public service. Nell Hutton is General Manager of Financial Markets at Westpac Institutional Bank and is responsible for fixing calm currency commodities and carbon markets globally and I’m sure that you’re very busy facilitating clients and the market to transition to this next extraordinary phase of wholesale markets. I have to also call out that Nell was the first woman to run a global financial markets business in Australia which is a real testament to you, a great feat, so well done on that. And Jonathan recently moved into Head of Domestic Markets at the RBA, I was going to suggest three or so months ago, but he tells me that it’s only six weeks, so he’s brand new into that new role. He leads the analysis of domestic financial markets and the Bank’s open-market operation, so you’ve an interesting career ahead as you manage the unwind of pandemic measures into the market. Jonathan also leads the carbon markets, the climate work for the Bank, which we heard this morning—for those of you who were there—is the third pillar, next to fiscal and monetary policy, for central banks; I don’t know whether Jonathan agrees with that or not. And also you may have come across Jonathan’s published research on international finance and macroeconomics. So welcome, Panel. Thank you for taking the time today.

We’ll run the panel in the usual way. The panellists will have a bit of a discussion and question amongst ourselves. We’ll open up to questions in the audience towards the end. I do ask that, if you have a question, you put your hand up. There will be people wandering around or perhaps standing at the back who have a microphone, so just make sure that you have a microphone before you start.

We’re here today to talk about wholesale markets, pretty important stuff for financial stability and also for funding the real economy and it’s really important that they operate fairly and efficiently. And they’re in a period of change, we’re seeing rapid growth; there’s more automation, the investor base is changing, and we’ve obviously had periods of stress just recently as well. And who would have anticipated that we’d be in this economic environment that we’re in now, which obviously is very impactful for fixed-income markets as well. We have rising inflation and rates, we’ve got geopolitical tensions, supply-chain shocks impacting commodities, energy and other parts of the economy. And then, following that extensive period of pandemic stimulus, we’re now entering an unwind phase, which much of it gets managed through the wholesale markets. So it’s been an extraordinary time for the debt market, part of the market that for a period was almost non-existent in the government space at least some time ago, to have grown to the size that it has. So there’s a lot of interesting discussion for us to kick off with today.

Maybe we’ll start by looking back at what’s changed since the GFC and over the more recent period. So, Nell, since you’re at the frontline and have visibility of some of these dynamics, can you just kick us off with some of the observations that you’ve seen in key trends in fixed-income markets and wholesale markets over the last little while, including during the pandemic?

Sure. Obviously, most of the last decade was characterised by the trend lower in growth and inflation, falling interest rates, and various accommodative policies from global central banks, which led investors to move further out the risk curve to seek yield and also damped volatility. Obviously, that’s changed pretty rapidly in the last 12 months, but that’s what’s characterised most of the last decade. And that culminated in the COVID crisis, where you had synchronised global efforts to implement emergency fiscal and monetary policy, and that has somewhat led to the rapid reversal that we’ve had in the last year.

In terms of COVID and the impact it had specifically, COVID did accelerate a lot of different trends, as we all know, and a couple of them that I’d call out would be the focus on social and environmental concerns. And, certainly, we’ve seen a real acceleration in sustainable finance markets since the start of the crisis, and that’s generated from both investor demand and also issue of focus on sustainable financing.

The other thing I’d call out is a focus from investors on the role of fiscal policy in supporting sustainable economic growth. And we saw that most recently with events in the UK, where Liz Truss’s mini budget generated a very violent response in UK interest-rate markets. And I think that’s a theme that we’re going to see - which is global investors focused on appropriate fiscal policy to support sustained economic growth, but Michael might want to comment on that later.

So it’s obviously been a really interesting period during COVID but even just more recently with some of the economic conditions, we’ve mentioned rising rates and inflation and the rest. How is the market coping with some of those changes to the [inaudible]?

Yeah. So it’s been a pretty rapid reversal we’ve seen this year, and I would say, generally, higher interest rates are good for fixed-income markets. But a move this fast generates a lot of uncertainty, and also the general uncertainty we have at the moment about the economic outlook makes it hard for both investors and issuers to assess what is fair value, both in risk-free markets and in credit spreads. And so what that generates is an increased risk premium, as investors demand a higher return on capital to invest. And so what we’re seeing is that the primary market has been characterised by probably a more defensive approach, either smaller volume, higher new-issue concession, potentially shorter tenures in the sort of three- to five-year sector or moving up the capital stack—so secured issuance or RMBS issuance—so I’d say the markets have been slightly more defensive. We’ve seen less corporate issuance, but corporates have benefited from liquidity in the loan markets, and loan pricing has been much tighter than bond-market pricing. The loan markets have lagged the move wider in bond markets, and so corporate issuers haven’t had to come to the market; they’ve been able to benefit from that continued liquidity in the loan market.

But, overall, the market has been very resilient and, that’s been a feature, I’d say, over the last 10 years that, despite some of the volatile times we’ve seen, it’s been very rare to see any sort of prolonged disruption in the market. And so I’d say, broadly speaking, the Australian domestic market is very resilient.

Okay. Well, that’s fantastic to hear. So, Michael, the government obviously needs to fund its spending and, during COVID, it spent a lot, and that funding is still coming through. So the AOFM is holding lots more bonds on issue than it has for a long time or potentially ever. What are some of the challenges that Australia’s biggest issuer or any issuers are facing in this current environment?

Well, as Nell said, the reflation of risk premia causes investors to wait and see, I suppose, and it also coincides with quite a bit of volatility. So I might just walk us through, I guess, the recent potted history. What we found in 2020 was that a fair bit of stock came back onshore from offshore investors, and that prompted the RBA to do a little bit of intervention at the time to maintain an orderly market. But what’s probably less known is that the domestic banks absorbed a lot of stock onto their balance sheet. I think it reached a peak of about 26 per cent of outstandings by about September 2020. But then, as the RBA moved into a more what I’ll call ’systematic’—but Jonathan might want to correct me—but, essentially, moved into—it had already established yield curve control but it had—well, colloquially known as ’yield curve’—sorry, ’quantitative easing’ and started to accumulate our bonds and built up to well over 30 per cent of the stock of debt, that tended to displace both foreign investors, who fell from 57 per cent of our holdings in December 2019 to around 45 per cent throughout this year.

But, having said that, foreign investors still stay engaged with the market and we’ve got … Well, essentially, about seven per cent of our staff are offshore at the moment, talking to investors, and another seven per cent will be getting on a plane on Sunday. So, we are still pretty popular globally.

And the other thing I’d note is that, as the holdings of the RBA grew, the holdings of the banks have fallen. So, while they reached a peak of 26 per cent in 2020, this year they’ve fallen below 10 per cent, which is actually lower as a share of the stock of AGS at any time since prior to the establishment of the Basel-3 liquidity regime. So that reflation-of-risk premium-market volatility, it created some challenges. Moreover, some central banks have been defending their currencies, and that has a tendency to impact the volatility of US Treasury markets and that can flow into our market as well.

But, by and large, as Nell said, we’ve seen markets as being resilient and we’ve signalled our intention to bring a new 12-year bond to the market next week, subject to the usual caveats about market conditions. So we continue also to hold sufficient liquidity at the RBA so that, if we need to, we can absent ourselves from markets for an extended period, but we haven’t needed to. But then it tends to be the case that the sovereign is the last part of the market that loses access to finance, so probably the more interesting question is in that credit space.

Okay. Look, that’s really interesting. There’s a couple of points there I think we’ll come back to, when we talk about investors. I think, the fall in the bank holdings, but they’ve got very significant holdings in the semis, for example and maybe coming back to have a look at some of those foreign investment dynamics. But maybe, Jonathan, if I move on to you, the RBA took unprecedented action during that COVID pandemic period to support the market, the Term Funding Facility, the Bond Purchase Program; the Committed Liquidity Facility, which was already in place but continued to support the market. Now we’re seeing unwinding of some of those measures. If you just step back and look at RBA’s role, how do you see that it’s evolved over time?

Well, there’ve been a range of elements of that. I mean, taking a step right back into sort of why we actually care about this, I mean the financial markets are critical for the operation of the economy, so it enables the investments. You need savers to be able to get their funds to investors so that investors can use them for productive purposes, and financial markets are at the heart of that, bond markets, and government debt markets in particular, are at the heart of that. So the government bond curve in particular, which is often what’s the focus for the RBA, that’s the risk-free interest rate in the economy, and the risk-free interest rate feeds into the pricing of everything, all of the debt-market equities, property, everything. So it’s really critical to have a well-functioning government debt market because that’s underpinning everything.

So you can look at our interventions in March 2020 in that light. This was the heart of the financial system, which was misbehaving, there was dysfunction in that market. So, there’s the practical measure in terms of what’s the government debt market, what’s the risk-free rate, in terms of the implications for the economy, and there are also more practical measures in terms of the government debt is used as collateral for so much of the financial system and so, if there’s disquiet about the use of collateral in that sense, then that’s significantly a problem.

The other point I would make is that broadly, I think, we can see the instability in financial markets is really bad for economic outcomes. You only have to compare. If we go back to the GFC, where we see the havoc that financial instability can really cause to your economic activity, most of the advanced economies suffered fairly significant recessions, and that was just because of financial instability. There wasn’t any real shock, there was just the shock in financial markets that was amplified by financial markets. But then, if you jump forward to the pandemic, you’d had a great deal of reform and regulation changes over that time that had been designed to make the financial system more resilient and more robust. And then, in the pandemic, we had a real shock—not just something happening within the financial market but a real, actual shock—and yet the financial system didn’t amplify that, it, by and large, worked to be able to modify it, to dampen that shock. Financial systems were able to smooth things out.

So, if you want to have a thought experiment of how bad things could be, imagine if you’d had the pandemic back in 2007 with the fragility of the financial market there and you had a real economic shock that hit when the financial market was not even able to withstand an internally generated shock. So I think that highlights just how critical a well-functioning financial market is for the operation of, the economy and, ultimately, that’s what we care about because that leads to people’s welfare and standard of living. So it’s really important for those fundamental reasons.

And, now that the RBA is going through a period of having to unwind some of those measures, how might current market conditions, and, if we think about some of the current market conditions … Obviously, you’ve talked about it being a well-functioning market;, but, when you’re factoring in what’s happening with inflation and rates and spreads in the market, including in swaps and other things, how is that going to impact that process of unwinding some of those measures?

So we do have a lot of unwinding to do, obviously, and a lot of that is pre-announced, so the unwinding of the Term Funding Facility, as you highlighted. The Governor has said that we will hold onto our bonds that we purchased under the Bond Purchase Program and yield curve control, and so that provides a degree of certainty for the market as well. But current conditions are obviously very important. So, we’re currently seeing what really is probably an unprecedented tightening by central banks globally. When you think about the speed of the tightening, it certainly compares in most circumstances to 1994, and the coordination of tightening across countries is really quite remarkable. And so that’s a potentially sensitive backdrop to think about things.

Fundamentally, if you think back to, say, the ’taper tantrum’ in 2013, where even the suggestion that the Fed was moving caused a degree of dysfunction in markets, the fact that we’ve had so many central banks tighten so significantly at a rapid rate and yet markets have continued to function pretty well, I think that’s actually a pretty positive thing at the moment. There are obviously some areas of illiquidty or dysfunction at times. I mean, we see that most strikingly in the swap spread at the moment, which is a little bit of a disruption.

But, overall, from what we can see, I think sort of market conditions are coping pretty well with the environment we’ve seen. We have had a well-structured timetable for how things are going to unwind, and I think that a notice period is very helpful. So, the banks know when the TFF is unwinding and that they will need to repay that, and so they’re able to plan accordingly, the banks can issue debt in advance of the unwinding of the TFF. So that notice period helps a lot for planning.

And you mentioned that you’re not going to be selling down the bonds, you’ll sort of watch and hold them through to maturity, that’s not the case in some other jurisdictions. And that point you were making about international stability, is that the key driver for choosing to hold on to them until maturity?

So the key driver for saying that we were going to hold them on for maturity is really thinking about how effective the bond purchasing is in the first place. So the expectation is that, if you tell markets you’re going to hold them, then they price them accordingly, whereas, if markets think that you’re going to sell them down in a short period of time, the price impact might be less. One of the things that’s different in Australia versus some other countries is the maturity of the bonds that we’ve purchased, and we generally have a shorter maturity than in some other countries, which means that it is going to wind off our balance sheet sooner.

Okay. Interesting, a really interesting period for you ahead and for the market. Maybe, Nell and Michael, just off the back that, what are your views on the impact of the unwinding, the likely impact on the market? Have you got anything to sort of add there in terms of whether its specific bond yields?

Look, we tend to think in terms of gross issuance tasks more than net. So a buy-and-hold investor who is going to let them roll off in time is probably the best outcome from a dampening market impact. However, what I would say is that there are some lines that are pretty tightly held. And so, when we think about things like the free float, that is quite low for some of the bonds. So it has meant that, over the last year or so, we’ve probably issued some of the shorter bonds, so sort of maturing in the next three years or so, to a greater degree than we might have if there wasn’t a shortage in the market. So, far from there being an indigestion problem, like we saw in 2020—where the RBA was stepping in initially to maintain market integrity—now, to the extent that there are issues, it’s a lack of free flow. And so we have sometimes competing but normally aligned objectives of maintaining the market and supporting the market but also meeting a portfolio-management objective. And when yields are very low, like they were until a year ago and, more importantly, the term premium is low before it reflated—that’s associated with QE and various other things globally—it tends to push our issuance bias longer. And so those two objectives can be competing, and so we’ve probably issued a little bit shorter than we would have otherwise. But we do put maintaining a liquid stable market pretty high on the agenda in terms of our objectives.

Okay. And it’s the market that’s been demanding that, or are you just observing based on the reflate issues?

Well …

In addition to sort of being there and buying them, are they sort of asking you to issue shorter dated?

They are. So, essentially, we’re a little bit unique in the sovereign-debt management community in the sense that we set an overarching strategy for the year, in terms of weighted average-term immaturity and various other metrics, but we don’t publish our issuance program months in advance, like a lot of our peers do. We survey the market weekly, and so we’ll have our druthers, if you like, what we’d like to issue, but then, if they’re all saying, ’We need April-24s’ or whatever it is, then we’ll tend to listen to them because, at the end of the day, if that conduit to our market and we use the auctions for the vast majority of our issuance and, if we don’t listen to what the people who turn up to those auctions want, then it means that they’ll go and buy a Jim’s lawn-mowing run or something like that instead of buying our bonds. What do you reckon, Nell?

Nell, did you have anything you wanted to add to that?

Oh, no. The only thing I’d add is, the important thing really is also just transparency and that there’s no surprises. So I think, the market is looking for clear guidance from the RBA, which I think we have, and, as long as people feel confident that there aren’t going to be any surprises, then, I think that’s the most important thing.

All right. So we might move on to talk a bit about the investor base, I mentioned a bit before that it has been changing. We’ve got, obviously, the growth of super funds and managed funds that are more active. The Australian banks we’ve talked about, even though their positions might have come down in the sovereign debt, they’re big holders of semis [semi-government bonds] for liquidity purposes. We’ve got potentially more market making as the markets are becoming a bit more automated. We’ve also got almost $2 trillion of bonds outstanding. And, again, listening to the themes of the rest of this conference, the enormous amount of financing that’s going to be needed to fund the transition into some of the sustainability financing, some of that or a good chunk of that is going to have to come from the debt markets, so diversity of investors is really critical. So maybe, Michael, starting with you, how has the investor base in government bonds evolved over time?

Okay. So, as I said earlier, the share held by the RBA has essentially popped up to above 30 per cent, but it will gradually unwind. So, putting that to the side, the share held by the offshore investors has drifted down to the mid-40 per cents and the banks’ has fallen below 10 per cent. Now, I would expect that, in the near term that will pick up for a number of reasons. Essentially, one is that they own so many of the semis that they’ve sort of reached a point that is comparable to the point they reached at various other points since the new liquidity regimes have come in, where you start to … Well, you would imagine you would start to wonder, if all the semis are owned by four players or a large majority of them, whether they’ll fulfil their role as a liquid asset. But that’s for others to decide, not me. At some point, you would imagine that they’ll start buying govies [government bonds] again, but the problem with that is that they’re very expensive on a relative-to-swap basis.

So, at the moment, the Exchange Settlement Account balances that the banks hold count towards the high-quality liquid asset holdings, and you can think of that as the other side of the RBA’s ledger to the bonds that they own of ours, rough and dirty. So, as those bonds, the short bonds, mature that are held by the RBA, those ES [Exchange Settlement Account] balances will naturally fall. The question will be, what do the banks do to fill that gap? That’s probably a question for Nell. Hopefully, I’ve got a few bonds to sell you. But we’ll see. Next week, you can roll on up. So, essentially, I would imagine that, if that is right and the holdings of semis don’t sort of keep creeping up towards 100 per cent, then you would imagine that T-notes would be popular, short bonds would be popular and bonds supporting the futures basket because they’re very easy to hedge for the banks.

On the index side, I would say that we’ve been a little bit surprised at the lack of demand for inflation-linked bonds, given there’s now inflation in this country, so … and also real yields have reflated. So, for a while, I could see why it was hard to sell an inflation-linked bond, because they had a minus sign in front of the yield and no one likes a guaranteed negative return. So, that has been a little bit interesting, although I would put in a plug for my colleagues in the Portfolio Strategy team by saying that we have not seen a whole lot of value in issuing inflation-linked bonds in recent years or decades and so we’ve kept the share of inflation-linked, as a proportion of our portfolio, at around about five per cent. That’s low compared to our sovereign peers, which tend to be about 15 or 20 per cent, and those guys are sort of suffering from pretty high spikes in their costs of funds. So I read something that said that the US Treasury, despite having 15 or 20 per cent of the share of its debt in linkers, has got something like half of its public-debt interest costs coming from linkers. That’s pretty impressive. We’ve kept it at five per cent, so ’Go team!’ Finally, it’s paid off. Now we just need them to buy them.

Just turning back to the point about the foreign investors, I guess I always sort of thought of 60/40 [per cent] sort of longer term as roughly the split. You speak of 57 [per cent] and it’s now down to 45 [per cent]. Do you sort of feel as though to continue to support the ongoing issuance that you need to really build back up that foreign investment? You’ve said that you’ve got seven team members jumping on a plane in a couple of days to get over there and start marketing and then …

Well, seven per cent of our team is over there …

Oh, seven per cent.

… but that’s two people.

Oh, okay.

It’s more impressive if you talk in percentages when you’ve only got 40 people in the office. Maybe it’s three people then, maybe my numbers weren’t so good. Look, it is important, and Australia has been an importer of capital for, well, the last 230-odd years, so it stands to reason that we’ll always have a pretty strong focus towards international investors. And they like us because we’re predictable, we have a good governance and government structure, and we listen to what they say.

And where are the super funds and the other funds in all of this? I know that they’re investing in offshore markets, and maybe we can come back to that in a second, but are they sort of actively engaging with you directly …

Look …

… in trying to increase their holdings?

Banks aside, the domestic market is not … How do I put this? So, Australian investment funds or investment managers who manage fixed-income funds like the fact that there are Australian Government bonds in the index so that, if they don’t own them, they sort of just earn a running yield by owning semis and everything else. I think that’s a fair comment, but Nell might want to clip me over the ear.

No.

Okay, fair enough. So, they don’t buy a whole lot of our bonds. Not since COVID but the last time I looked at it, I think we added up all of the shares owned by everyone and they’ve left roughly five or 10 per cent for everyone else in Australia, including their super funds.

Okay.

But the super funds that do have large holdings are the defined benefit funds.

Yes.

But, obviously, that’s a small proportion of the super fund market in Australia.

And most of the defined benefit funds are government, so, ’left pocket/right pocket stuff’, it’s sort of a bit of a wash. But, there are a few still out there.

State government and federal government.

Oh, that’s right true; yes, true.

Are you planning for that to change over time, or are you expecting that, as the rate environment is changing, super continues to grow? We’ve got all of this capital in these super funds in Australia that they just have to start transitioning into sort of direct investment in some of those holdings?

Oh, look, I think the defined benefit funds will always have a demand for government paper, and I think the contribution … Sorry, the defined contribution funds are probably going to be looking for credit product to generate the yield that they need to deliver retirement outcomes.

I think it’s fair to say though that there have been one or two notable investors who have taken a very deliberate long-duration position through that great moderation in inflation that Dr Kearns was talking about earlier, and I think their performance bears that out. So I think that, to the extent that markets are efficient in this space, you would imagine that they would get a reputation for being on the right side of things. And, now that risk premia have reflated, including the term-risk premium, you would imagine that there would be potentially additional demand in domestic fixed-income investors.

I’d agree with that. And I think the other thing we’re seeing from the larger super funds is global government bond markets as an opportunity to generate alpha, so trading across global government bond markets.

That was going to be my next line of questioning around the international investor base that there has sort of historically been a pull for Australian investors to go offshore. Is that starting to change? Is there something about the Australian market that makes it either more appealing or less appealing as it changed over time, or do you continue to expect that there’s going to be heavy demand abroad?

So I think … I mean, back to, I guess, the theme around super funds, what we’ve seen in the super-fund space and probably in the institutional-investor space more broadly is a trend towards consolidation and, as there’s been a focus on economies of scale and they’ve become more sophisticated and had more complex needs, two key things have come out of that. One is the need to increase the proportion of global investment to diversify, and the other is more demand for hedging products, including swaps and futures, to solve some of the solutions they need. So I think, yes, the domestic market still has an important role to play and, largely, we’re seeing, supply met with demand. But, as the institutional market in Australia—and particularly the super-fund market—continues to grow rapidly, they are going to continue to need to diversify internationally. But, I think the domestic market will still have an important role to play.

Great, thank you. Just one final question on the client base. Picking up from another theme that came out this morning in the crypto discussion around digital tokens, I was a bit surprised to hear a Professor of Finance mention that there is some research out there that is suggesting that digital tokens will account for about 10 per cent of GDP by the end of the decade, not all in the debt space but, clearly, some of it will have to be debt based if that’s to come true. Is there demand from clients and investors to be tokenising these assets?

So I’d say, ’Generally, no.’ I mean, we are working on a number of use cases for digital currency, particularly, for example, around international payments, where potentially having a digital coin can help drive efficiency. But, generally, we’re not really seeing any demand from either investors or corporate customers at this stage. So, as a bank, we’re obviously wanting to be at the forefront of these trends and be across it, but it’s not one of our top priorities in the near term just based on a lack of real interest from our customer base.

Does anybody else have a comment on that: digital tokens?

I mean, not so much on digital tokens. But, as Nell said, central bank digital currencies is somewhere that …

Predicted?

It’s an area that’s at the forefront in terms of research and work, so either a wholesale digital currency or a retail digital currency. There’s been a lot more work done on wholesale, and I think, the use cases for that seem to be stronger at the moment. The Reserve Bank of Australia has done some work on the wholesale with international settlements. We now do have a project for retail, we’re looking at the use case for that. But, we have a very developed and advanced financial system in Australia and so that takes away some of the retail case, so we still have to see what retail case will be made by people.

All right, thank you. We might just circle back to expand on some of the comments earlier about resiliency of liquidity. I’m interested sort of not just in the stress conditions—in the extreme stress conditions that we saw during COVID and GFC—but looking at other times as well. Are there aspects of the Australian market that might make us more vulnerable to shock events than other jurisdictions? I hear what you’re saying in terms of the well-functioning market. But, if you look across the range of different products, the greater use of swaps, for example, and not a strong sort of repo market as in other jurisdictions, are there aspects of our market that might create vulnerabilities, do you think? That’s open to anyone but maybe starting with you, Jonathan.

Sure. Everyone looks this way. Look, I think there are strengths and potential weaknesses of the market, and I think, we need to acknowledge those. The first thing is to think, ’Well, we got through previous shocks, we got through the GFC, we got through COVID, so we can be confident about the strength and resilience of the financial system.’ I think, as soon as anyone said that, they would be famous last words, so just be clear that I’m not saying that. There are some parts of the market that function very well. So, we have a very liquid FX market. The swaps and futures around that market, the derivative market, have functioned very well, and I think there are a lot of countries where, when I speak with counterparts, they’re envious of how well that functions because that does enable the Australian financial system and Australian institutions to take out a lot of risk, and, if you don’t have currency risk, that’s a really big deal. But there are some other parts of the market that perhaps seem less robust than you might find in other systems, whether that’s the private repo market or we’re seeing the swap market at the moment gapping in ways that are sort of a bit disturbing, and I think we have to be always very attentive.

As you’ve said, I’ve been in this job for about six weeks now. For the previous five years, I was head of the Financial Stability Department, so we’re always worrying about these kinds of shocks and risks and what can go wrong. And I think, as soon as you start thinking that things are stable, that’s when problems will occur. We only have to look at what happened with the gilt market in the UK to see where problems can arise very quickly, even when there was some expectation that things were generally well contained. So, there would be significant hubris to suggest that, no, we’re fine.

And just picking up that point on the gilt issue in the UK and how that flowed through to our market. I’ll come back to you in a second to get your views on this, Michael. Do you have a view, given, I mean, that it’s a relatively recent impact on how the Australian market weathered?

I mean, certainly every morning, when we look at what’s happening, the developments overseas from overnight are very significant in terms of what’s setting the starting conditions for the Australian market and how things trade through. I mean, the Australian yields and liquidity have responded to what’s happened internationally already. So, that certainly caused issues in terms of, we’d see the currency move, we’d see liquidity affected and yields affected. So, in a global market, these things certainly always transmit through to Australia as well.

But I do think … and, sorry, Michael might pick up on this, but I think that period we saw of UK defined-benefit pension funds selling Aussie RMBS [Residential Mortgage-Backed Securities]. I’m sure that most people are aware of that was on the back of volatility in UK gilts, which forced UK pension funds to fund margin calls, and they sold some of their non-core assets, some of which were Aussie RMBS. I would say what really was remarkable about that was how resilient the market was. That really, the RMBS market didn’t really blink. And so, that’s encouraging in terms of the liquidity in RMBS.

Yeah, absolutely. I mean, in that event, we saw that the amount of selling from UK pension funds, at least reported, was fairly significant relative to the issuance that we would normally expect to see, so …

It helped that it was very short-dated, the instruments that they were selling, because that’s also the least expensive for them to sell. But still, they were selling them at auction in competition, it could have had a much more significant impact on the market than it did.

There was one notable case where I saw a Beewick list come across my desk, we weren’t bidding on it, by the way, let’s be very clear about that, but I recognised some of the lines as ones that we owned and I did a double-take, and we’d already received a call notice on some of the notes that were being put in for auction. So what that means is that someone is trying to sell a note that the issuer is going to repay within two weeks. So either they just weren’t being very discriminating when they were putting their lists together or they needed two-week money. But the fact is that those two weeks have now passed and those Beewick lists have slowed right down. So it’s not clear which of those two it was, but it was very weird.

What I might do is just continue on with you, Michael, and I’ll come back to you in a second, Nell, on your observations both on dealing and on syndication. But, Michael, AOFM was asked to intervene in the securitisation market at sort of various points over the last decade or so since the GFC and during the COVID pandemic, which is somewhat unique amongst sovereign-debt management agencies. How did AOFM intervene, and can you share some lessons on how that played out and also how the recent volatility in the credit markets that we were just talking about that flow through to the Aussie RMBS market. What was the impact of that? Is that sort of leading to calls for AOFM to get back in the market?

So the first question was about the lessons from it. But I think the flippant answer to that is because we’re talking about resilience today—if you really want to test the resilience of your sovereign-debt management agency, you’ll give them a $15-billion structured finance support fund to implement in the middle of a pandemic, which sees their issuance task go to $200 billion. We’re an agency of about 40 people and it takes about six months for a new employee to get a security clearance. Make of that what you will.

Anyway, the second question - What was it about? It was about the LDI selling. So, yes, we have been asked. We’ve been approached by some originators and, interestingly, financiers of originators to get the band back together and turn the structured-finance-support spigot back on. We don’t have a mandate to do that. So, to be clear, the Structured Finance Support Fund was all about maintaining access to finance for smaller lenders who would otherwise lose access to reasonably priced finance as a result of COVID. COVID is not behind the current volatility in the market.

So, to be really clear, we do not have a mandate to just start buying securities at will because people don’t like the price. And, as the other panellists have said, the securitisation market has held up very well in the face of quite a fair bit of—yes, short-dated—selling from overseas where the seller was not very discriminating on price. So, when you’ve got a liquidity crunch and you’re the liability-driven investors don’t assume that they are about to go belly-up or anything, on the contrary, the spike in long gilt rates means that their liabilities are getting revalued in their favour much more quickly than their assets. So this is really a margin call on the derivatives that they use to partially hedge those liabilities.

So it’s a bit like a wheat farmer who finds that they’ve got a bumper crop but there’s been some sort of global event that causes a shortage of wheat—oh, I don’t know: someone invades Ukraine, for example—and suddenly, they’ve sold wheat futures into the market. They get a margin call on that wheat futures, but they’re sitting pretty because, in three months’ time, they’ve got a lot of wheat to come in to sell at record prices. So just substitute out the wheat farmer and substitute in a liability-driven investor and that’s the position they’re in.

So there’s no real issue here other than that they were forced to sell to raise liquidity. And, in that situation, you sell the assets you can, and it’s a real vote of confidence in the Australian securitisation market that they sold Australian RMBS. Now, they didn’t only sell Australian RMBS, they sold Dutch and other countries’ RMBS, but it held up well. It displaced a little bit of supply, there were one or two deals that got pulled. I think that’s as much about credit spreads widening and people not liking the price or—how do I put it— suddenly, if you’re writing prime mortgages that are in competition with the banks who get 60 per cent of their funding from deposits, you’re going to struggle to compete with them. And so your need to empty your warehouse is probably not great because you’re not going to be originating at a rate of knots, if you’re competing with banks who can get 60 per cent of their funding from deposits and your spreads have gone from 50-over to 200-over in the space of a year. So, anyway, I think the market is doing all right.

Okay. We won’t expect to be reading about it in the newspaper then in the headlines.

No, I wouldn’t expect that you’d be reading that I’ll be buying RMBS any time soon, even if I could.

Nell, I might just loop back to you then. From your dealing operations, what factors come into play when you’re looking at liquidity, especially in sort of changing market conditions, and your ability and willingness to provide liquidity, looking at it from a dealer perspective initially? So, when we’re looking at, for example, the size of the bond market now, the position that the banks have and some of strain that we’re seeing in terms of pricing and volatility and other things, are they all key to drivers for your willingness to provide liquidity?

So, and I’d start by saying, we’re very focused on providing consistent liquidity and in challenging times, it’s more important than ever that we support our customers in the provision of liquidity. We very much see it as a long-term partnership. So, in times of stress, we need to be there because, you know, it’s a long-term relationship.

But I would pick up on a point that Jonathan made earlier around, as an example, recent moves in swap spreads and the EFP market as, a function of, the challenging environment that we have had post financial crisis. Some of the regulatory constraints that were introduced which reduced the capacity of dealers to warehouse risk, I mean, this is not just in Australia, this was globally, but it has an impact in a smaller, less-liquid market like Australia, have meant that, at times, the flows can be very one way. So, if you get a significant, for example, corporate hedging flow in the swap market, there can be market indigestion, which means that there’s a lot more risk around taking on those transactions for the dealers than there was 15 years ago. So we do have to be thoughtful around how we manage any larger flows. And there’s been obviously a lot of focus on particularly how you manage larger price-sensitive transactions because it is more challenging than it was prior to the financial crisis.

But, overall, we will always make prices and we will always support our customers even when it is more challenging. But we do have to be very transparent with our clients on the best way to tackle markets, because sometimes it may not be that the best thing is for us to take down all of the risk, it may be that we need to share some of the risk over time and manage it over time, in order to minimise market impact.

And, moving on to your syndication business, in periods of liquidity stress, how is that impacting issuers and their ability to bring deals to market?

Well, I guess, as we’ve sort of talked about, there’s no problem for the AOFM, no problem for semi-government issuers. Those markets remain very liquid and strong; financials also. We saw last week that ANZ issued the largest-ever bond in the Australian domestic market, CBA issued the largest-ever tier-2 deal, $2 billion, in the Australian domestic market, there were larger new-issue concessions than we would have seen a few months ago, but, equally, volume was no problem. So I think, certainly for government, semi-government and financial issuers, the market has been very resilient.

As I said earlier, we haven’t really tested the corporate market much because corporates haven’t really needed to access the market. But that will be … I guess that the next test will be when we start to see some corporate primary issuance or more significant corporate primary issuance than we’ve had so far. But, overall, primary markets are strong. And, as I said, issuers have various levers that they can pull, whether it’s new-issue concession, smaller volume, shorter tenure, higher in the capital stack. But those are always the factors that are being weighed into consideration.

I guess that the other important one is speed to market. We can accelerate deal-time lines if there is concern around specific event risk. Again, it’s harder for a corporate to do that than for a financial issuer or a government issuer. But certainly, accelerated timing is another lever that we would always consider.

Quite. I’m just conscious of time, so what I might do is just open up to the audience. If there is anybody in the audience that has a question, can I just ask you to put your hand up?

Just to Nell’s last point, while you’re looking for someone to put their hand up, the other tool that we have started to use is signalling intent further out. So, we always give ourselves that out, which is subject to market conditions being suitable to doing the deal. But signalling our intent a little bit further in advance gives people a bit more notice to think about the supply that’s coming.

Yeah, that’s definitely helpful as well.

Right. I can see that we’re inundated with requests from the audience! So what we might do is just have a bit of a discussion about some of the policy issues. Globally, you’ll be aware, certainly, Jonathan will be aware from some of the international forums that there’s a lot of discussion happening about the resilience of debt markets, focusing I think on those sort of extreme liquidity events, so looking at 2020 but also looking more broadly at the resilience of markets. And there’s a whole range of different policy initiatives that are being thought about from sort of pre and post trade transparency, enhancing that, promoting more use of multilateral platforms or all-to-all trading, about central clearing of transactions, which has been talked about for some time in relation to repos and government bonds and those sorts of things. What are your views in exploring some of these things for the Australian market? Who wants to go first? Jonathan?

Sure. I mean, some of these things we do see …

To some extent, anyway.

… in other … Well, there are some of them in the Australian market, but we also see some of those features in other markets and, by and large, I think a lot of them are seen to be beneficial, and that’s why they’re being discussed more broadly. Trade transparency does seem to have, in most circumstances, been beneficial. There’s the question of how much transparency, how quickly, to get that balance right so that you have a return for those who are going to be active in the market. But, certainly, there are things that I think we will want to look at, globally, the regulatory community, and in Australia, to think about how we can improve that resilience.

If we think back to March 2020, it’s not every year that you see a one-in-100-year pandemic, fortunately, so that was a pretty extreme event. And you would think that there are going to be times when you do need a degree of public-sector support or intervention, but you’d want to minimise how frequently that occurs. So, when you just have a little bit of liquidity in the market because of market dynamics, some run-of-the-mill event, that’s certainly not when you would want to be seeing public sector intervention required. And it would be nice if the market was resilient even through a March-2020 event, but there was a huge degree of uncertainty. If you think about the social and economic environment that we were looking at back then, it was pretty severe. So we can probably park that event to the side and just think more generally about the resilience of markets.

What’s your view … There you go.

Look, I agree, and that’s got nothing to do with the fact that I was at the pointy end of having to do one of those interventions, or three now actually. But it does strike me that you can kind of train the market for government intervention. I did the math the other day and, of the 169.5 months since Lehman Brothers collapsed, the AOFM has either owned structured finance products or been planning to buy it for all but seven months, and this was originally a temporary targeted timely something-or-other—something else starting with ’T’—intervention. So we sold out of the last of our GFC intervention in February 2018 and, by September 2018, we were planning another intervention called the ’business securitisation fund’. And we put that on hold for the pandemic, and now we’re back to doing that. And so it probably shouldn’t surprise us that, when spreads blow out 100 points, the originators just, ’dial Michael’.

There’s no downside, other than getting your head bitten off. I do note though and this is a bit of … if there are any budding PhD students out there, I do note though that there are different approaches and this challenge. We compare ourselves with our peers within the OECD who have similar sorts of philosophies on debt management and what-not, and they tend to be the Canadians, the Nordics and the New Zealanders. And, of the Canadians and the Nordics, they had different approaches to securitisation-market intervention. So the Canadians have got this long-standing arrangement called the Canadian ’Mortgage and Housing Corporation’ that essentially morphed from a post-World War II scheme to ensure that returned service people got access to housing, and then, you turn your back on these things for 40 years and they’re the size of the Tax Office. But, essentially, they have a permanent place in the mortgage market in Canada. There’s no private-lenders mortgage insurance market, and I think the two things might be related. And then, at the other end of the spectrum, New Zealand, I think, did not intervene in the pandemic, like we did with the Structured Finance Support Fund.

So it’d be an interesting question, I think, to look at the three jurisdictions, Australia, New Zealand and Canada that are sort of similar in other aspects as to how we approach debt management and see whether the end users of securitised finance in those countries had a different outcome. So are Australians that much better off because of what we did with the Structured Finance Support Fund than the New Zealanders, who sort of looked at it and didn’t do it, or are the Canadians in a much better position because they’ve just always had this stock standard sort of government backstop for liquidity of the residential-mortgage-bank securities market? So I don’t know the answer, but I’d love to. So, if anyone wants to do a research project.

Show of hands?

I’m Acting CEO for the next couple of weeks, so get in fast.

We’re almost at time. But, Nell, did you have a reaction to maybe the point on all-to-all trading? Is that something that’s been talked about in some of those international forums? Is that even a proposition that would work, if you’re looking at the whole range of investors?

Look, I think it has its challenges. Certainly, we’re obviously open to innovation. But, if you look at how long it’s taken the market to get on top of the raft of reg change that came through after the GFC, including the current trade reporting rules and everything else, I think there’d be some time before we got ready to head in that direction.

All right. Well, thank you. That’s a great way to finish. We are at time. I just want to thank the panel. It’s been a really interesting discussion. You’ve made a topic that can be quite complex sound quite exciting. There’s a lot that’s been going on, so thank you for sharing your insights.

Just a couple of housekeeping things: for those of you who are here tomorrow, we recommence at 9am for the first session on corporate values in a changing world, and, for those who are registered for the dinner, drinks and canapes start in half an hour, at 5.30, downstairs. I just encourage you to join me in thanking the rest of the panel for making their time available.