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Legal and regulatory framework for developing government bond markets

Second OECD-China forum on public debt management and Government Securities markets

XI´AN; September 2005

José María FernándezHead of the Public Debt Department

Spanish Treasury- Ministry of Economy and Finance

1

AGENDA

• Legal framework.The development of the Central Administration debt market

The general public debt framework.

• Primary market regulation.

• Regulation of the government securities market.

• Supervision of the government securities market.

• Final remarks.

2

The market development

GROSS ISSUANCE AND OUTSTANDING CENTRAL GVT. DEBT (in mll. Eur)

134.342

319.299

50.000

100.000

150.000

200.000

250.000

300.000

350.000

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

Gross issuance

Outstanding debt

SECONDARY MARKET TURNOVER(in billion euro; includes all types of transactions registered at the

book entry system)23.731

0

5.000

10.000

15.000

20.000

25.000

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Source: Tesoro and Iberclear

The development of the Spanish debt market starts from the first half of the 80´s.

The growing deficits and, consequently, larger outstanding debt volumes encouraged the Treasury and the Bank of Spain to set up an efficient, transparent and liquid secondary market for the debt.

As Spain joined the E.M.U., the fiscal consolidation process and debt management strategy implied a lower gross issuance but the activity on the secondary market kept growing

3

The market development: the general frameworkGovernment debt issuance:

o The Spanish Treasury (Ministry of Economy and Finance).

o The Bank of Spain acts as financial agent of the Treasury.

Government securities market:

o Shared regulatory capacities: Spanish Treasury, Bank of Spain (BoS) and CNMV (Securities Market Supervisor).

o BoS acts as market regulator and has, until 2003, operated the book entry and settlement system.

o CNMV and BoS in charge of supervising the debt securities markets and their participants.

o Close cooperation among different agencies is in place through different mechanisms.

4

AGENDA

• Legal framework.

• Primary market regulation.Legal basis for the government's borrowing authority.

Key guidelines for the primary market.

• Regulation of the government securities market.

• Supervision of the government securities market

• Final remarks.

5

Primary market regulation

Art 135 of the Spanish Constitution grants the Government the right to issue public debt.

o Debt issuance must be regulated by an Act approved by the Congress.

o Annual interest and redemption payments of outstanding public debt must always be included in the Central Govt. Budget.

The General Budgetary Act (1988 ref in 2003) defines:

o The concept of public debt and the definition and functions of the Public Treasury.

o Information disclosure commitments related to public debt issuance.

o Empowers the Minister of Economy and Finance to manage the Central Government debt.

o Defines issuance procedures and debt management operations.

o Defines the rights granted to the tenors of public debt and the generic properties of G.S.

Every year the Annual Budget Law sets a ceiling to the growth of the Central Government (CG) debt. This limit is proposed by the Treasury based on net forecasted figures for the CG deficit, the net change in financial assets of the government and the net change in the cash position of the Treasury's account at the BoS.

Every year a Ministerial Order signed by the Ministry of Economy and Finance specifies the securities to be issued, auction features and issuance calendar.

Issuance and debt management operations are published in the Official Gazette.

6

Primary market guidelines

General objective:

o Meet the Central Government funding needs at the lowest possible long term cost.

Secondary objectives:

o Ensure an acceptable level of risk for the debt portfolio.

o Set up cost efficient and reliable issuance procedures.

o Be predictable and transparent.

o Promote the liquidity of the CG debt market.

o Promote a diversified distribution of the debt portfolio.

o Promote the competition in and competitiveness of the primary market.

o Promote the development of the financial markets.

o Provide the market with a risk free term structure.

7

AGENDA

• Legal framework.

• Primary market regulation.

• Regulation of the government securities market.

Legal basis for the government's securities market.

The structure of the government's securities market.

• Supervision of the government securities market

• Final remarks

8

Secondary market regulationThe Securities Market Act (1988 reformed in 1998) regulates the secondary markets for financial securities:

o The public debt market is defined as a regulated market. As such, market access (for securities and participants), information and publicity disclosures and the type of transactions and market procedures are defined in this law.

o BoS is appointed regulator of the Government debt market.

o An Advisory Board of the debt market is set up.

o Access to the market is restricted by institutional (credit institutions, investment firms, international financial institutions, central securities depositories and national central banks are let in), solvency and technical and managerial capabilities criteria required.

o Different solvency standards are set for direct account holders and custodians.

o Membership is based on formal opinions made by the CNMV and the BoS and is granted by the Ministry of Economy and Finance.

9

Secondary market regulationThe Securities Market Act (1988 reformed in 1998) regulates the secondary markets for financial securities:

o A national book entry system (B-ES) first regulated in a decree of 1987 is incorporated. Initially set up and managed by the BoS and since 2003 merged with the stock market book entry system to create IBERCLEAR.

o The B-ES has two layers: Upper level –wholesale side of the market, direct account holders at the system- and the lower level -custody agents serving final investors-.

MARKET TURNOVER BY MARKET SEGMENT (total annual in million euros)

0

4.000.000

8.000.000

12.000.000

16.000.000

20.000.000

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

upper level lower level

10

Secondary market regulation

BONDS TURNOVER BY MARKET SEGMENT IN 2004

Low er level73%

Regulated upper level

17%

SROs10%

The Securities Market Act also allows, since its amendment of 2002, the set up of SROs.

o Currently there are 2 Automatic trading systems (SENAF and MTS Spain) with self regulatory powers in government debt trading.

o Around 30% of the government securities traded between market members are crossed in the existing ATS. In 2004 10% of the secondary market bonds turnover took place in ATS.

o SROs are licensed by a decision of the Cabinet, after positive report issued by the CNMV.

o The BoS must also issue a positive report of the book of rules of each SRO.

o Each SRO has a ruling body chosen by its members empowered to organize and supervise trading as well as to arbitrage in their conflicts.

LETRAS TURNOVER BY MARKET SEGMENT IN 2004

SRO27%

Regulated upper level

31%

Low er level42%

11

AGENDA

• Legal framework.Key legal policy issues.

• Primary market regulation.

Legal basis for the government's borrowing authority.

• Regulation of the government securities market.

• Supervision of the government securities market.

• Final remarks

12

Public debt market supervision

Shared responsibilities between BoS and CNMV.

CNMV is entrusted with overall supervision, inspection and enforcement powers in relation with securities markets and their participants.

BoS has supervisory and inspection powers with respect to participants in the Spanish market for Government debt and to credit institutions.

The Securities Market Act mandates that CNMV and BoS must coordinate their activities:

o Main principle: prudential supervision of a financial institution operating in the securities market corresponds primarily to the supervisor where the financial company is registered. Issues dealing with the functioning of the securities market correspond to CNMV.

o To reinforce coordination: CNMV and BoS must document the coordination scheme under a Memorandum of Understanding plus a system of cross membership in their Boards of Directors exist.

Until 2003, throughout the development and maturity of the debt market, the BoS was entrusted with the management and supervision of the book entry system. Now Iberclear is responsible and must provide any information required to ensure adequate supervision of the market.

13

AGENDA

• Legal framework.Key legal policy issues.

• Primary market regulation.

Legal basis for the government's borrowing authority.

• Regulation of the government securities market.

• Supervision of the government securities market.

• Final remarks

14

Final remarks

Given the important role of public debt market and its special nature, the Spanish Government promoted its development via a clear regulation, a high level of coordination among the different public entities involved and the following objectives:

To satisfy the government funding needs at the lowest possible long term cost given an acceptable risk level.

To guarantee the integrity and efficiency of the primary and secondary government securities market.

To ensure its transparency and the protection of investors.

To promote the liquidity of the Spanish debt market.

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Jose María Fernández- Deputy Director of the Treasury; Head of the debt departmentjfernandez@tesoro.mineco.es

tlf: 91 209 95 29/30/31/32fax: 91 209 97 10Reuters: TESOROBloomberg: TESOInternet: www.tesoro.es