1. The role of debt policy in the development of a derivatives market
Fifth annual OECD-World Bank Bond Market Forum
June 2-3, 2003
Thomas Olofsson, Head of Funding,
Swedish National Debt Office

2. Goals for debt policy Minimize costs under due consideration of risks
Policy implications: Liquidity, predictability, openness and transparancy
Liquidity and attractivness of a market is enhanced by a well-functioning derivatives market

3. Why derivatives? Derivatives part of a complete market
Enables achievement of desired portfolio and risks
Step to efficient capital market
Gains for both investors and Debt Offices
External effects for the whole economy

4. Management of exposure
Debt Office could use derivatives to separate borrowing from exposure
Investors could hedge investments in bonds
Market makers could use derivatives to manage risks
Foreign investors could invest without taking exchange rate risks

5. Pre-requisites Underlying instruments needed
Deep and liquid market with transparent and well functioning price mechanism
Usually the Government supply debt instrument providing a reference curve (benchmark)
Repo market important

6. Organization
Market could be set up by private player or group of e.g. banks or an existing Exchange
Whole transaction chain (pluming) important
Clearing and settlement function
Central Clearing Counterpart (CCP)
Credit and other risks
ISDA/CSA agreements

7. Swedish experiences 1980’s two players in options (OM and SOFE)
Market killed by transaction tax
OM merged with Stockholm Stock Exchange
OM set up an interest rate ’futures’ market with settlement, but trading OTC with banks as market makers
Swaps (and some options) provided OTC by foreign and domestic banks
Currency derivatives traded by foreign and domestic banks

8. Swedish experiences
Attempt to set up a proper futures exchange with OM as market provider failed
Idea was to create a very liquid market for interest rate risks, giving great opportunities to manage risks and price discovery
2 and 10 years were traded aiming to create benchmark pricing
Not only Primary dealers could participate, electronic trading, real real time price discovery
Investors appreciated the price discovery, but to few actively traded
As turnover was to small it was abandoned

9. Swedish experiences
Today we are back to OTC-traded ’futures’ cleared by OM Stock exchange
Useful as a complement to spot market
Turnover small compared to spot market
Many investors use the Bund market for risk management and short-term positions as the bond yield a spread fairly stable short-term
Derivatievs in term of swaps is deep and used by e.g. Debt Office for duration adjustment and managing foreign currency exposure
A smaller option OTC market also exists

10. Role of Debt Office Debt Office/Central bank/MoF
As a large player it is possible to influence market participants and market development
Different alternatives possible:
As owner or partner in setting up institutions
As speaking partner, mediator or example
PD-agreements and fees could be used demanding certain behavior
Selection of counter-parties is another opportunity
Relying on spontaneous market development could be futile
Larger banks often ends up in grid-look and make improvement difficult

11. Role of Debt Office
Debt Office own participation could affect market development
As a market participant you contribute to the liquidity and development
However, avoid to be too dominant
Swedish Debt Office use of CSA-agreements has facilitated the use such agreements – development of market practice

12. Comments
Derivatives contribute to liquidity and attractiveness of the fixed income market
An exchange traded future market requires strong turnover, liquidity and participation to be benchmark for risk management and pricing
Debt Offices/CB/MoF can contribute to market development of market structures as an important costumer, issuer of benchmark bonds, state representative, partner or mediator
Derivatives are important in debt management
A very successful derivative market not decisive for the bond market