Hans J. Blommestein

Governments and the Market for Longevity-Indexed Bonds

Uncertainty about length of life, longevity risk, is a growing financial problem for pension funds and annuity providers. Unfortunately, there is a lack of financial instruments to hedge against this longevity risk, thereby complicating risk management by pension funds and hindering the expansion of the annuity market. Consequently, this paper examines the role of government in promoting a private market solution for longevity hedging financial products. Governments could in principle improve the market for annuities by issuing longevity-indexed bonds and by producing a longevity index. The paper argues that the first public policy role is hampered by the fact that governments are themselves already exposed to significant longevity risk. However, governments could take other steps such as producing a reliable longevity index.

Interactions Between Sovereign Debt Management and Monetary Policy Under Fiscal Dominance and Financial Instability

This paper argues that serious fiscal vulnerabilities arising from many years of high government debt will create new and complex interactions between public debt management (PDM) and monetary policy (MP). The paper notes that, although their formal mandates have not changed, recent balance sheet policies of many Central Banks (CBs) have tended to blur the separation of their policies from fiscal policy (FP). The mandates of debt management offices (DMOs) have usually had a microeconomic focus (viz, keeping government debt markets liquid, limiting refunding risks etc). Such mandates have usually eschewed any macroeconomic policy dimension. For these reasons, all clashes in policy mandate between CBs and DMOs have been latent and not overt.

NEW STRATEGIES FOR EMERGING DOMESTIC SOVEREIGN BOND MARKETS

The forces shaping the revolution in banking and capital markets have radically changed the financial landscape during the past three decades. A remarkable feature of this changing new landscape has been the astonishing rate of internationalisation of the financial system in the last two decades, with emerging markets becoming increasingly important participants. At times, this participation led to an excessive reliance on foreign financing, making the participation of these countries in the global financial system more vulnerable to shifts in expectations and perceptions. The sovereign debt management strategy suffered from many structural weaknesses, failing to take into account international best practices in financing budget deficits and developing domestic government securities markets. Consequently, emerging markets experienced serious financial crisis episodes. Against this background, the paper focuses on new and more sophisticated strategies to develop domestic bond markets, taking into account the risk profile, complexities and other constraints of emerging markets. The paper’s central thesis is that risk-based public debt management and liquid domestic bond markets are important, mutually reinforcing strategies for emerging financial markets to attain: i) enhanced financial stability, and ii) a more successful participation in the global financial landscape. It will also be shown that this twin-strategies approach requires taking a macroeconomic policy perspective. Le paysage des marches de capitaux internationaux a change de maniere drastique au cours de ces dernieres annees. Un levier particulierement puissant de ces changements a ete celui de l’internationalisation des marches financiers au cours des deux dernieres decennies, les marches emergents acquerant en particulier un nouveau protagonisme. Cette reemergence s’est, dans le passe recent, accompagnee de crises et de turbulences, la dependance a l’egard des flux de portefeuille etrangers s’accompagnant d’une vulnerabilite accrue de la part des economies emergentes, tributaires des changements d’anticipations et de perceptions prevalant sur les marches internationaux. La strategie de la gestion de la dette d’Etat a ainsi pâtit de nombreuses defaillances, se trouvant notamment incapable de prendre la pleine mesure des meilleures pratiques internationales en matiere de financement budgetaire et de developpement de marches de capitaux locaux solides. En consequence les marches emergents ont aligne les episodes de crises financieres. Le papier ici presente met en perspective les evolutions les plus recentes et avec elles la profonde transformation en cours des marches de capitaux emergents. Il souligne en particulier l’apparition de nouvelles strategies de gestion des risques lies aux dettes emergentes, des strategies plus sophistiquees prenant davantage en compte le profil des risques sous-jacents, ainsi que les nouvelles complexites et contraintes dominant les marches emergents. La these centrale du papier est que la combinaison des gestions actives des risques de dette publique et la prise en compte des liquidites affluant vers les marches de dettes domestiques sont des strategies qui se renforcent mutuellement pour : i) atteindre une plus grande stabilite financiere ; ii) optimiser l’integration de ces economies dans le systeme financier international.

New Strategies for Emerging Domestic Sovereign Bond Markets in the Global Financial Landscape

The forces shaping the revolution in banking and capital markets have radically changed the financial landscape during the past three decades. A remarkable feature of this changing new landscape has been the astonishing rate of internationalisation of the financial system in the last two decades, with emerging markets becoming increasingly important participants.At times this participation has led to excessive reliance on foreign financing, making the participation of these countries in the global financial system more vulnerable to shifts in expectations and perceptions. The sovereign debt management strategy suffered from many structural weaknesses, failing to take into account international best practices in financing budget deficits and developing domestic government securities markets. Consequently, emerging markets experienced episodes of serious financial crises.Against this background, this article focuses on new and more sophisticated strategies to develop domestic bond markets, taking into account the risk profile, complexities and other constraints of emerging markets. The articles central thesis is that risk-based public debt management and liquid domestic bond markets are important mutually reinforcing strategies for emerging financial markets to attain (1) enhanced financial stability, and (2) a more successful participation in the global financial landscape. It will also be shown that this twin-strategies approach requires taking a macroeconomic policy perspective.

Local Currency Bond Market Development in Sub-Saharan Africa: A Stock-Taking Exercise and Analysis of Key Drivers

ABSTRACT This article studies the current state and drivers of government local currency bond market (LCBM) development in Sub-Saharan Africa. We first show that, increasingly, African governments issue fixed-rate local currency bonds with tenors of ten years and more on a regular basis. However, African LCBMs are also often marked by illiquidity, very few corporate securities, and narrow, bank-dominated investor bases. Second, we present an econometric analysis of the drivers of African government LCBMs based on a new high-quality, OECD-compiled panel dataset. LCBM capitalization is found to be correlated negatively with governments’ fiscal balance and inflation, and positively with common law legal origins, institutional quality and democracy.

Evaluating the Design of Private Pension Plans: Costs and Benefits of Risk-Sharing

The principal purpose of this paper is to analyse the trade-off between the uncertainty in contributions on the one hand and benefits on the other that is embedded in different pension arrangements. The paper employs the funding ratio (ratio of assets to liabilities) and the replacement rate (ratio of benefits to salaries) as key criteria for evaluating the risk sharing characteristics of a private pension plan from the perspective of the plan member. The stochastic simulations performed show that hybrid plans (those in between traditional DB and individual DC) appear to be more efficient and sustainable forms of risk sharing than either of the other two. Of the three main hybrid plans analysed, conditional indexation plans appear to have the greatest potential as sustainable forms of risk sharing.

Uncertainty and Risk Management after the Great Moderation: The Role of Risk (Mis)Management by Financial Institutions

Since the early eighties volatility of GDP and inflation has been declining steadily in many countries. Financial innovation has been identified as one of the key factors driving this ‘Great Moderation’. Financial innovation was considered to have improved significantly the allocation and sharing of financial risks, both from a macro and micro perspective. In particular, the prevailing opinion was that great progress has been made in developing models and other quantitative methods for measuring and managing risk. However, the global financial crisis that started in the summer of 2007 revealed important failures in risk management by financial institutions. Over-optimism prevailed and risks were underpriced, caused by problems of both a conceptual and technical nature. This paper analyses these two angles from the viewpoint of financial institutions. Conceptually, we will show that risk management degenerated into a ‘pseudo’ quantitative science. This in turn gave a false sense of security to financial institutions and their supervisors. Prior to the crisis, supervisory and regulatory regimes assumed that for the financial sector as a whole, risk management had been improved and that, as a result, financial stability was enhanced. The fact that many financial activities were carried out in a rapidly changing landscape – i.e. key decisions had to be taken in situations with uncertainty - was largely ignored. At a very fundamental level it was mistakenly assumed that all uncertainty can be measured in a reliable fashion using a probability distribution – i.e. all uncertainty can be treated as ‘risk’. This attitude had also adverse consequences for the way risk management and decision making were organised in financial institutions. There was too much focus on quantitative models and measurement and too little on the qualitative dimension of risk management, involving such issues as information flows, people and their motives and incentives. In addition, even from a narrow, technical perspective risk management techniques proved to be insufficiently sophisticated. The second part of the paper focuses on the lessons to be learned from the past episode of inadequate risk management at the level of financial institutions. Apart from technical improvements there is a need for a greater emphasis on handling fundamental uncertainty. More specifically, it will be shown that qualitative risk management is particularly important to deal with the latter uncertainty. However, even with better risk management the future remains uncertain and human nature will remain largely unchanged. Finding better ways of dealing with fundamental uncertainty remains therefore a continuous challenge.

Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk

This paper builds a dynamic general equilibrium macro-finance model with two types of borrowers: entrepreneurs who want to produce and gamblers who want to play a lottery. It links central banks interest rate policy to expected cash flows of both types. This link enables us to study how the interactions between various shocks and different monetary policy rules affect the borrower pool faced by financial intermediaries. We find that when the economy is hit by an expansionary monetary policy shock, the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level after a short period. It is lowest when the central bank does not react to output fluctuations. Quite differently, not reacting to output fluctuations avoids a persistent worsening of the borrower pool in the long run if the shock is a bad productivity shock.

Statistical Yearbook on African Central Government Debt: Overview of a New OECD Publication

The borrowing needs of African governments are increasingly met by issuing marketable debt instruments. Leading practices from OECD governments exert an important influence on debt management and the functioning of markets for sovereign debt instruments. This first issue of the Statistical Yearbook on African Central Government Debt provides comprehensive and consistent information on African central government debt instruments. It includes individual country data but also comparative statistics to facilitate pan-African (cross-country) analysis. JEL Classification: G2, G28, H63 Keywords: African borrowing needs and debt instruments, public debt management, Statistical Yearbook on African Central Government Debt

Capital market reform in Asia : towards developed and integrated markets in times of change

Preface Introduction I: DEVELOPMENT OF CAPITAL MARKETS IN ASIA Banks and Financial Intermediation in Emerging Asia: Reforms and New Risks - M S Mohanty and Philip Turner How to Develop Capital Markets in East Asia - Andrew Sheng II: ISSUES OF CAPITAL MARKET REFORM Capital Market Reform in Malaysia - Zarinah Anwar Non-tradable Share Reform in the Peoples Republic of China - Xinghai Fang Trends and Best Practices in Shaping OECD Public Debt Management and Government Securities Markets - Hans J Blommestein Ten Years After: Implications of the Current Financial Market Turmoil - Atchana Waiquamdee Facing the North-Atlantic Financial Crisis: A European Perspective - Hans-Helmut Kotz III: EMERGING RISKS AND CHALLENGES OF REGULATION, SUPERVISION, AND CORPORATE GOVERNANCE Corporate Governance: An IOSCO Perspective - Jeremy Cooper Governance of and by Institutional Investors in the OECD Area - Stephen Lumpkin Restoring Trust in Financial Markets - Stephen Grenville Financial Sector Supervision: What We Have Learned So Far - Stephen Grenville Investor Protection in the Asia Pacific: Survey Findings of the Asia-Pacific Regional Committee - Lynn Hew and Mohammad Nizam Ismail The Elephant in the Room: The Need to Deal with What Banks Do - Adrian Blundell-Wignall, Gert Wehinger, and Patrick Slovik IV: REGIONAL CO-OPERATION AND INTEGRATION OF CAPITAL MARKETS IN ASIA A New Financial Market Structure for East Asia: How to Promote Regional Financial Market Integration - Gordon de Brouwer and Jenny Corbett The Integration of Capital Markets in the Asian Region: Some Practical Steps Forward - Gordon de Brouwer and Lorraine Allan The Asian Bond Fund-2 and Regional Initiatives - Thirachai Phuvanatnaranubala The Role of Capital Markets in Infrastructure Financing - Worapot Manupipatpong Index