Treasury Committee
Oral evidence: The work of the Debt Management Office, HC 2082
Wednesday 8 May 2019
Ordered by the House of Commons to be published on 8 May 2019.
Members present: Nicky Morgan (Chair); Rushanara Ali; Simon Clarke; Colin Clark; Charlie Elphicke; John Mann; Alison McGovern; Wes Streeting.
Questions 1 - 60
Witnesses
I: Sir Robert Stheeman, Chief Executive, Debt Management Office, Jo Whelan, Deputy Chief Executive and Co-Head of Policy and Markets, Debt Management Office, and Jim Juffs, Chief Operating Officer, Debt Management Office.
Witnesses: Sir Robert Stheeman, Jo Whelan and Jim Juffs.
Q1 Chair: Good afternoon. I thank the representatives of the Debt Management Office for being here this afternoon. We were trying to work out when the DMO was last before the Committee, and we think it was probably some time ago—certainly not in the past two years but perhaps a bit before that. It is very nice to see you here. I am going to ask the panel to introduce themselves very briefly and then we have a series of questions.
Sir Robert Stheeman: My name is Robert Stheeman. I am the chief executive of the UK Debt Management Office.
Jo Whelan: I am Jo Whelan. I am the deputy chief executive and my focus is on looking after our policy and our markets areas.
Jim Juffs: I am Jim Juffs. I am the chief operating officer of the Debt Management Office.
Q2 Chair: Thank you all very much indeed. Sir Robert, you have my sympathy about being on crutches; I was on crutches last year. I know it is not always the easiest to sit down for a couple of hours but hopefully we will not be that long.
I was going to start with gilt auctions and borrowing. Planned gilt sales for 2019-20 have been revised up by £3.7 billion, compared with the plans published at the spring statement in March. Perhaps you can talk us through that. Does it cause you any particular issues or concerns when a revision like that happens in a fairly short space of time?
Sir Robert Stheeman: No. The short answer is that there are no concerns arising from that. It is a routine revision that always occurs in April. The change is the result of what we call the outturn of the central Government net cash requirement from the previous year. It takes into account what we have borrowed in total. It is really a revision of the number that was published at the time of the spring statement. I know it is a lot of money, but just over £3 billion in the overall scheme of things, compared with the total financial requirement, is not that much.
Q3 Chair: Is there a size of increase that would be a challenge?
Sir Robert Stheeman: Arguably, yes, but if you ask me what that number is, the honest answer is that I probably do not know. It is perhaps worth noting that in previous years there have been quite significant changes at times, not so much in April but during the course of the financial year. The obvious example was what happened 11 years ago in the financial year 2008-09, when we started off the year with a gilt sales programme of about £80 billion. That October, as the financial crisis developed and the bank recapitalisation in this country occurred, that number was revised to, I think, £110 billion. Just a month later, at what was then called the pre-Budget report, it went up to £146 billion. Literally four months later, we started the new year at what was then and is still the record of £227 billion. I say that to give you a sense of how the numbers can change, but also to give you a sense that the market is usually pretty good in adapting to that number and, if necessary, absorbing it.
Q4 Chair: Perhaps you could talk us through how it works between the DMO and the Treasury, in terms of the increases and what notice you would expect to get. Does how much notice you are given affect it? You have talked about some pretty big numbers there. Is it just a question that, whatever the Treasury throws in your direction, you will try to find a way for the market to absorb it?
Sir Robert Stheeman: To some extent, that has to be the case because our role is to try to ensure that we keep Government financed and liquid the whole time, every business day of the year. We have to make sure we can deliver whatever that financing requirement is. Having said that, in terms of dealing with changes and unanticipated changes during the financial year, as a general rule, the later in the financial year that that happens, the more of a challenge it is for us and the market.
The reason for that is that we can only schedule a certain number of auctions or operations in a market-friendly fashion. If you try to telescope that into a very brief period, there is a danger that we are perhaps approaching the market in the wrong way or becoming too much of a burden on the market. We will also need to make sure that we can, as far as possible, absorb, for instance, increases through our cash management function, which is a little like a treasury function. The gilt issuance programme is an overlay on Government cash flows throughout the year.
Q5 Chair: Has the DMO ever pushed back on the Treasury and said, “We are going to find this difficult,” “You have not given us enough time" or, "We need more time to schedule more auctions"?
Sir Robert Stheeman: We have, it is fair to say, said, "This is going to be difficult". That was probably at that time. But that does not mean it is something we find so difficult that we would not want to contemplate it. We have no choice. Government have to finance themselves. To be fair to the Treasury, it will engage with us as soon as it is aware of any major change coming. It always does that. We have a very regular dialogue with the Treasury, literally daily and sometimes several times a day, in terms of the financing requirement.
What we think is important is the way we communicate our strategy to the market for dealing with those changes. We talk a lot about being open and predictable, and doing that in a very transparent fashion. We will try to make sure the number of changes to the programme, which is preannounced, are as few as possible. One thing that markets do not like is surprises. We try to keep those to an absolute minimum. The market knows, for instance, that there are certain set points during the year when those changes can occur. You mentioned the April revision, which is an annual thing. That is usually the smallest and the easiest to deal with.
Q6 Chair: Because it is expected.
Sir Robert Stheeman: Because it is expected and because the change since March is unlikely to be very big. It literally reflects five or six weeks maximum. Usually, the biggest change will occur halfway or two-thirds of the way through the year at the time of the Budget, now in the autumn. We are one of the few parts of Government and the Treasury that still stick to the old cycle of the financial year, which starts at the beginning of April.
Q7 Chair: If you had to raise a lot of money in a hurry—you have mentioned the financial crisis—perhaps you could talk us through how you would do it and what the maturity profile would look like.
Sir Robert Stheeman: To take a step back, if everything is fine, we will provide advice to the Treasury, which ultimately goes to Ministers, about the shape of the borrowing requirement for the year. By the shape, I mean what we will be issuing in gilts, effectively in four distinct categories. The first three are conventional or nominal gilts. We divide that up into shorts, mediums and longs. The second category is index-linked gilts. We agree on that. If there is a change to that, we will have to work out whether we want to try to maintain the proportions that we set out at the beginning of the year. In general, if we can, we very much prefer doing that. It says quite clearly in the published “Debt Management Report” that Government policy is not to change the overall shape of the gilt remit during the year unless certain things happen.
One of those things could be a significant unexpected increase in the financing requirement. If that happens, we may deem it necessary, for instance in a short period of time, to change the profile of issuance. A good example—again, I am talking about 2008-09—is an increase that we undertook then in the shorter maturities, up to seven years. The reason for that is that it is the deepest, most liquid, most easily accessible part of the market for us. That is where we can borrow more, more quickly. To give an idea, you can see that reflected in the size of the auctions that we hold. The current year suggests that a long auction will be in the region of £2.25 billion or something like that, but a shorter-dated auction could be as much as £3 billion. The market can absorb more in shorter maturities than it can in longer maturities.
Chair: It does not take very long in these sessions to reach Brexit. Presumably one of the unexpected events could be around Brexit. I am going to ask Rushanara to ask questions about that.
Q8 Rushanara Ali: Good afternoon, Sir Robert. When it comes to the current potential Brexit outcomes, which are likely to upset the future gilts market most and which least?
Chair: It depends on what the outcomes could be, of course. We will work on some of the standard ones.
Sir Robert Stheeman: In general, it is fair to say that what the markets deem to be a bad outcome will affect us most on the face of it. By bad outcome, from the market’s perspective, that probably means some kind of no-deal Brexit. Having said that, my gut feeling is that the markets might be affected in a way that people do not immediately think is quite so obvious. Let me explain what I mean by that.
There is a sense in the market, rightly or wrongly, that if there was a no-deal Brexit—to use language that I prefer not to, but I will use on this occasion—and we were to crash out, as they say, with no deal, there is a sense in the market that the policy response coming from the Bank of England and the monetary policy authorities might be much more accommodative. That is not a comment from me; that is a view in the market. Whether it is correct, I have no idea, but in that case, with a very accommodative monetary policy, it is entirely conceivable that gilt yields, certainly in the short end, would fall rather than rise.
That is why I say that is perhaps slightly counterintuitive. A lot of people imagine that gilts will surely fall in a negative scenario. A lot more depends, from the market’s perspective, on what the monetary policy authorities’ response to the actual situation will be. It is for that reason that all the headlines on Brexit over the last 12 months—longer even—have tended to affect the currency market, so sterling, much more than the gilt market, which you might even say has been uncannily quiet during this period. It is because the market does not quite know how to price these two, arguably very extreme, outcomes that might be out there that it does nothing. You are even seeing that now reflected in the currency markets, because sterling has been remarkably stable for the last couple of months, if you think about headlines.
Q9 Rushanara Ali: Should we draw from that that it is because the market does not really know?
Sir Robert Stheeman: You can. I agree, yes. It is certainly the conclusion I would draw from that. There are some people who believe that, if you were to have a positive outcome for the market, and by that they mean for sterling in particular, something that could lead to a sterling rally, such as some kind of agreement, a withdrawal agreement or even going as far as another referendum—whatever it is—the currency will rally but the bond market will fall. It is all slightly counterintuitive.
Q10 Rushanara Ali: Moving on to broader perceptions, the popularity of the UK’s gilts has been attributed recently to us being considered a safe haven by some analysts. First of all, do you agree with that assessment? How do you respond to some recent speculation that, post Brexit, sterling may no longer be considered a reserve currency? Does that ring true to you?
Sir Robert Stheeman: That is a really good question. On the safe haven aspect, that certainly held true during the financial crisis in particular. One must not forget that the financial crisis was a crisis of the financial sector. Arguably, what we have now and what might happen in a negative Brexit scenario is not a crisis of the financial sector, per se; it is more of a political, and I hope not economic, issue.
Q11 Rushanara Ali: Even in a no-deal situation, if after the delays and so on we still end up crashing out?
Sir Robert Stheeman: By financial crisis, I am referring in particular to the financial sector and the banking sector. Even in a no-deal scenario, I would like to think that there is no need for some kind of major bail-out of the banking sector as occurred 10 years ago. That is what I would say.
Q12 Rushanara Ali: That is using quite an extreme case, right?
Sir Robert Stheeman: It is, but I am trying to give a sense. However, to try to answer your question directly, sterling—and perhaps how the UK is perceived more generally in the market—has become, interestingly enough, since the beginning of this century, since 2000, a little more of a reserve currency than it was in the immediate 10 to 20 years beforehand. If you take the latest IMF statistics—the IMF publishes statistics of reserve holdings across the world—sterling accounts for 4.5% of central bank reserves in the world. That does not sound very much but it is not insignificant if you consider that reserves are still dominated by the US dollar and that the euro accounts for roughly 20%. Sterling, to a certain extent, has punched above its weight.
I detect behind your question perhaps another question: what would it take to make markets really nervous? You perhaps have to think about things such as credit ratings, of which I am normally quite sceptical because credit ratings have not always been accurate in the past. A one‑notch downgrade or something like that is unlikely to have much, if any, effect at all. Where you start talking about a significant downgrade where we might lose, for instance, the AA status we currently have, while I do not want to paint an overly negative or dramatic scenario, and this is not even a Brexit-related thing, that scenario could lead reserve managers globally to reassess the whole basis on which they have made assessments over the last years about the viability, strength and stability of the currency, and the viability of our bond market and gilt market, which is essential for us.
That could be an issue, but one tiny thing we perhaps have in our favour is that the international investor base, by international standards, is not that large; it is about 28%. It is big. It is a lot bigger than it used to be, but the investor base for gilts, which we issue, is still dominated by the domestic UK pension industry.
Q13 Rushanara Ali: Are you planning and preparing for those sorts of scenarios? How does it work? You have laid out some extreme circumstances. How does the organisation think about these sorts of issues in terms of risk management and so on?
Sir Robert Stheeman: In as much as we can, we try to plan. I have mentioned that we have a very close dialogue with the Treasury. We do. We have talked to it about a lot of these scenarios and what that might mean in all sorts of ways. Some of the things that interest us perhaps more closely in the DMO are not just Brexit in a wider sense but what Brexit means, for instance, for the regulatory framework in which some of our gilt-edged market-makers have to operate. We think a lot about those sorts of things. We watch that carefully. What does Brexit mean in terms of, for instance, exemptions that we currently enjoy under EU regulation, prospectus exemptions and those sorts of things? We discuss that.
In terms of wider planning, we have discussed a number of scenarios, without going into too much detail. We have discussed them in some detail. You can discuss as much as you like. We are talking about markets here. Markets are driven by human beings, who will react in different ways. One thing we cannot do at the DMO is predict exactly what markets are going to do, even if I have been doing that for the last 10 minutes.
Q14 Alison McGovern: I have some non-Brexit questions. Starting off with index-linked gilts, we have seen the proportion of the wholesale market increase by 2.5% over the past five years. It is the Government’s policy to reduce the proportion of index-linked gilt issuance in a measured fashion, they say, over the medium term. Can you say how easy that is going to be?
Sir Robert Stheeman: We have in the UK, compared with other countries, an unusually high measure of exposure to inflation in the debt portfolio. In the entire debt portfolio, it is roughly 28%; 29% of gilts out there are index-linked gilts. You are talking about a nominal value there of about £430 billion. That is a very large part of our debt portfolio. The Government, in response to both the OBR’s fiscal risks report and the NAO’s report on Government borrowing, made it clear at the time of the Budget last year that they are looking to reduce the inflation exposure. Let me rephrase that: not specifically reduce it, but make sure the issuance does not continue in an unconstrained fashion. If we were to maintain the level of inflation-linked issuance that we have at this current level as a percentage of what we issue, given the nature of the product, over time—the Government have published projections about this—you would expect to see that 28% increase.
I said we were an outlier. To give you an idea, the next closest country is probably Italy, which has about 13% of its debt in inflation exposure. The United States has about 10%. We are an outlier. What was announced was that we would do it in a measured fashion. The word “measured” is important because we do not want to frighten the market. I mentioned the importance of the domestic investor base a moment ago. They are the ones who particularly value this product. They are core to what we do, but we also want to put them on notice that that figure will come down. In this year’s financing remit, inflation-linked issuance is down by 2% compared with where we were a year ago.
Q15 Alison McGovern: I will come back to pension funds in a moment, if I may. Before we discuss that, how does the Government’s preference play out in terms of the way you act and make your choices about gilt issuance?
Sir Robert Stheeman: Specifically on inflation‑linked gilts, I should say I very much agree with the Treasury’s line on this. I feel personally that, if you are an outlier, and you cannot justify being an outlier because you do not have a model that tells you this is what you should be doing, it feels slightly uncomfortable to have the idea that one part of your debt is increasing in an unconstrained fashion. We have spoken to them. Throughout the period in which we agree the advice to Ministers about how this year’s financing requirement should be delivered, we have engaged in a debate as to what we think is the best strategy to do exactly that. I can genuinely say that the planned reduction in issuance this year, in percentage terms, is one that we not only fully support, but I would like to think we played a part in getting there, knowing that the Government have this preference. The Government set out the preferences.
Q16 Alison McGovern: What is your best analysis of how we got to this situation?
Sir Robert Stheeman: In terms of the high exposure, the UK has been issuing inflation-linked debt since 1981. As such, I believe we were the first major country of the modern era to issue inflation-linked debt. It has become a great thing to do for many countries now but we were the first. Over time, because embedded in the instrument is the so-called inflation uplift, this portfolio, in nominal terms, has increased regardless. There was also a period, especially in the mid to late 1990s, when in the UK we had this huge amount of demand, which we referred to, from the pension fund industry, which led to us having an inverted yield curve. In plain English, long-dated yields were lower than short-dated yields, which is unusual.
That inverted yield curve was, to some extent, the obvious reason that we, for many years, focused a huge amount of our issuance on long maturities and long inflation-linked maturities in particular, because it was more cost-effective than issuing in the short end. We have a cost minimisation objective. We felt that issuing long-dated inflation-linked debt was extremely good value for money. We still believe that, but our objective also talks about balancing cost and risk. The Government and the Treasury have deemed the amount of inflation in the portfolio to be perhaps uncomfortable, in terms of a potential constant increase over the years.
Q17 Alison McGovern: It reduces our ability to mobilise inflation in reducing the debt burden.
Sir Robert Stheeman: It could but, as a good debt manager, you would not expect me to say that is our objective.
Q18 Alison McGovern: No, that was not a question; that was a comment from me. To come back to pensions, we have seen much change in our pension system since the period you mentioned and a switch from defined-benefit to defined-contribution pensions. Could you say a little bit about how that has affected your work?
Sir Robert Stheeman: So far, the effect of that has not been that marked in the gilt market. The reason for that is that the amount of unhedged exposure in pension fund liabilities—by unhedged, I mean exposure to longevity and to pension pay-outs that are linked to inflation—has been so large that there has been this overhang of demand for the inflation-linked product. However, because defined-benefit schemes have become very rare—we already see the first signs of this, and very few defined-benefit schemes are still open to new entrants—we expect to see the maturity profile of that demand beginning gently to decrease.
You may be aware that we have a very, very long average maturity. That reflects what I have just been talking about: our desire to issue as long as possible. Demand in the market is beginning to shorten, not massively, but what we refer to as the sweet spot of demand used to be around 40 to 50 years, especially in the inflation-linked side. Maybe it is a little closer this year to 30 to 40 years. That message was also given to Ministers in the annual consultation meetings that are held in the Treasury.
Q19 Chair: On pension funds, one of the things there is quite a lot of lobbying about is in relation to funding of infrastructure in this country. There is a lot of discussion about whether pension funds should have more of an ability to invest in infrastructure. I do not want you to comment on that but, if the pension funds were to find other things to invest in, would that affect the markets you are operating in?
Sir Robert Stheeman: It could, although the numbers we are talking about are so vast. Jo, do you know what the estimated pension fund liability is close to? It is over £2 trillion, I think.
Jo Whelan: Yes, it is. It depends also where in the life cycle of the pension fund the funds are coming from. If you have a defined contribution-type structure and it is interested in real return, so it might invest in equities and infrastructure, that would not necessarily be in contention with a defined-benefit scheme that is locking down its liabilities and trying to cash flow match because the pension scheme is quite mature. The ideal asset for that might be some form of gilt. It is not necessarily in contention with that.
Q20 Mr Clarke: If I can turn to debt maturity patterns, in the minutes from the financing remit meeting on 21 January, the gilt-edged market-makers noted that index-linked demand has recently moved from the ultra‑long sector to the 20 to 30 year area of the curve. How has that shift in requirement affected your medium to long-term planning?
Sir Robert Stheeman: That follows on very nicely from what we have just been talking about. Let me take a step back. I mentioned at the very beginning that we divide up issuance into four distinct groups, or maturity buckets. For conventionals, we have a specific bucket of longs, which is 15 years plus, but “plus” can and does mean out to 50 years or sometimes even slightly longer. For inflation-linked debt, we do not have specific maturity buckets. One thing that is delegated to us within those parameters is the choice of which bonds we issue and when. We can issue perhaps fewer 40 or 45 years, and more 30 or 35 years. That is how we react to that. It still qualifies as long-dated issuance but we are actively trying to respond to these changes in investor patterns in the market.
Q21 Mr Clarke: What is causing that shift in investor patterns and why are they seeking a slightly less long-term debt issuance?
Sir Robert Stheeman: It is very much linked to this issue of the nature of the underlying demand, the fact that pension schemes have matured and that there are very few long-term new additional liabilities being created, so that demand begins to shift gradually shorter. Through a period of arguably unprecedented issuance over the last 10 years, we have perhaps maximised deliberately the amount we have done in long and very long maturities. My personal guess is that over the next 10, 20 or 30 years or so, the UK will still have—because it is the nature of the investor base as well—this very long average maturity. It is not likely to remain as long as it has been.
Q22 Mr Clarke: Does that make us unique or does that mirror other ageing western societies?
Sir Robert Stheeman: In terms of the trends, it slightly mirrors it. What is unique is what we have been able to make out of it for the debt portfolio itself. In the fact that our average maturity is now over 15 years and that of the United States is just under six years, we are a complete outlier there as well, but you might argue a positive outlier. It is something that rating agencies have commented about favourably. I would see that gradually reducing over time. It is a little like a super tanker. For that to change significantly, it will take a long time.
Q23 Mr Clarke: In terms of the meeting you had with GEMMs, investors and Scottish gilt investors on 25 January, it was noted that short and medium-term index-linked gilts should be used to cover reduction in the take-up for long-term conventional gilts. In terms of longer-term risks or, indeed, potentially unintended consequences, is there a risk that, for example, you might have a higher than expected redemption level in any given year if you have more debt coming due, say potentially in 2019, in year, or in the next couple of years?
Sir Robert Stheeman: There is a risk. Our role is to try to manage that as best we can. At the same time, the nature of that risk you have to think about quite carefully. You are right. This year we have a record amount of redemptions, maturing gilts—effectively almost £100 billion. The actual new net cash requirement is much smaller, so a key question for us is how we refinance that, so we have a number of big, lumpy maturities. Effectively, we are trying to spread that out over as many maturities as possible. We do that within the buckets or across the buckets that I mentioned, but we also do it across specific dates so that we do not have too much maturing on one date. It is certainly not unheard of for us to have a single gilt that matures on one date in excess of £30 billion, in terms of payments, coupon payments, as well as the nominal amount that we have to pay back. These are vast amounts. That is where the cash management function comes in.
Another risk that was highlighted in this meeting—this came out of the minutes—is a sense that the market felt, perhaps surprisingly, “Goodness, we are losing £100 billion of existing gilts. We like short‑dated gilts because they are liquid and easily tradable. We therefore want to see a little more in short-dated gilts than we have perhaps in recent years.” We have tried to increase, marginally—not by a significant amount—the amount of short-dated gilt issuance to reflect that. The short end of the market, as I said earlier, is very deep and very liquid, which means we can access that market whenever we want, within reason, and in the biggest size. It is the part of the market that enjoys the largest participation across all investor groups. We have a vested interest in trying to do what we can with our issuance to keep that market healthy.
Q24 Mr Clarke: There is no evidence, therefore, of any problems in rolling over our debt burden.
Sir Robert Stheeman: Not yet. I do not want to predict something for the future.
Mr Clarke: That is not the most reassuring answer I have ever heard.
Sir Robert Stheeman: No. Again, compared to other countries, this redemption profile is remarkably benign. There are some countries in Europe with similar economies that have huge amounts rolled over each year. You are right: it is the ability to roll over and refinance every maturity that is key.
Mr Clarke: Relatively speaking, it is in exceptionally good health. Excellent, and on that cheering note—
Q25 Chair: The DMO is, what, 19 years old?
Sir Robert Stheeman: It is 21. We have come of age.
Q26 Chair: To the situation that Simon was just talking about, and particularly where we started, with significant issuances around the time of the financial crisis, are things playing out as was expected when the DMO was set up? Because it is only 21 years old, is this situation a first for the DMO to be facing? Are there any wider lessons?
Sir Robert Stheeman: That is a really good question. I do not think anyone expected in 1998 that we would have issued what we have issued. To throw some numbers, which I like doing, between 1694 and 1998, the UK borrowed roughly, in nominal terms—and I know there is something called inflation—approximately £360 billion. That is over 304 years. In the last 21 years, we have borrowed about £1.5 trillion[1]. You have to look at nominal and in relation to GDP, so it is quite fun for me to throw out these numbers but, as a serious point, nobody anticipated that. The fact that we were able to do what we have done, on a scale that was genuinely completely unforeseen by anyone, is a testimony to the market and its ability to be almost elastic in absorbing more, but also, if necessary, absorbing less. In the first few years of the DMO’s existence, we were really focused on trying to maintain liquidity and just having enough to issue. That might seem a long time ago now but we have tried to adapt.
I have to say that the people who work there are fantastic. They are unsung and they do a superb job. Some of them, both Jim and Jo, have been with the DMO since day one.
Q27 Wes Streeting: Oh, to be 21 again. I have some questions about inflation. As you will know, this Committee and, in particular, the House of Lords Economic Affairs Committee have been thinking quite a bit about measures of inflation. Do you think the current RPI measure of inflation is currently the best inflation index for the UK gilts market?
Sir Robert Stheeman: I am not a statistician. Some of my best friends are statisticians.
Wes Streeting: You can nominate them to appear before the Committee—they definitely will not be your friends after that.
Sir Robert Stheeman: I am willing to accept their opinion. Even I can vaguely understand that RPI is flawed. They have said that. They are the experts and, as much as I understand, I utterly agree with them. The question then arises: what does that mean for the gilt market? The reason we issue RPI and only RPI-linked gilts is not because we, in the DMO, have a particular belief in RPI as a measure of inflation. The reason is that that is what the demand is for. The liabilities of the pension industry are still heavily linked to RPI, even if it is a bad and flawed measure. That is where the liabilities are. That creates the demand. That is why we issue into it. That is the main reason.
Q28 Wes Streeting: I take from that that you would agree with the view expressed in the minutes from your meeting with gilt investors in Scotland in January that it might be unrealistic to see the launch of CPI gilts in the near future. Do you agree with that? If so, is it almost entirely for the reason you have just set out in terms of pensions liability, or are there some other factors we should take into account too?
Sir Robert Stheeman: The Government have said that they will make a response to the Lords report. The fact that that response has been delayed is a sign that the Government are thinking extremely carefully, alongside the UKSA, about what needs to be done in this situation. From where we sit, for us to start issuing anything that is linked to a different or new index, we would need to believe that that issuance is sustainable over the long-term and is not just a one-off. For that to happen, we would need to have real clarity over this whole discussion, as everybody else wants, about inflation and where we need to go.
We try as much as possible with our issuance, when embarking on a new instrument or any instrument, unless there is a specific reason for us to do otherwise, to have a sustainable market that we know we can continue to issue in, over time add liquidity and build up benchmarks. Until we know what the situation is with inflation, we do not know. I should add that CPI liabilities have been increasing. They are not, probably by a long way, nearly as large as RPI liabilities with the pension funds, but that number has been increasing. We watch it carefully. The statement we always put out is that we keep it under review. That is meant genuinely. We consulted eight years ago on the possible issuance of linkers linked to CPI. There were various reasons then that the market felt we would not want to do so. From where I sit now, I would want to have clarity over the Government’s preferred measure of inflation first.
Q29 Wes Streeting: That is totally understandable. There are a couple of questions that follow from that answer. First, have you been involved, as the DMO, in the discussions taking place around the impact of any changes arising from the House of Lords Committee report?
Sir Robert Stheeman: I have.
Q30 Wes Streeting: What modelling have you done to forecast the effects of using a different inflation index on the gilts market? If you have done this work, what were the findings?
Sir Robert Stheeman: We have done no direct modelling, but let me give you an example of what we think about. This is a very sophisticated market—sophisticated in the sense that people know exactly what they are buying. If RPI is flawed—and I am sure it is—the market knows it is flawed. The market knows it is getting more from a linker linked to RPI than it would otherwise. Were we to issue, for instance, something like CPI, which we could probably do, we should not assume that we will get what we got for RPI-linked issuance. The market will simply offer us a [lower][2] price.
That differential between CPI and RPI will reflect quite precisely what people refer to as the wedge, which is the difference in value between RPI and CPI. From where we sit, in terms of value for money for the taxpayer, we should not think we are going to save money by issuing something like CPI because we will be paying out less; we will also get a lower price. These are the sorts of things we discuss with the Treasury and try to articulate with it.
Q31 Wes Streeting: That leads me on to a final question about some of the numbers that are put about on precisely this point of how much the taxpayer might be losing. The “Measuring Inflation” report estimates that using RPI has cost the UK Government £1 billion a year in higher interest payments to bondholders. Do you recognise that figure?
Sir Robert Stheeman: Partly. I have discussed that figure and people in the Treasury have discussed it. Some people who are slightly cleverer than I am have come to the conclusion that it might not be exactly that number. It depends how you discuss it. Let me give you one example. This is a hypothetical situation. If the payments we make were linked to CPI, yes, we would be paying less. I repeat what I said: we would be getting less money for it. Were there to be—this is purely hypothetical—a change to RPI and to the way it is calculated, we would be paying out less on the stock of existing gilts, but any change for the future would mean that we would receive less, if that makes sense.
Q32 Wes Streeting: That makes perfect sense, but would you characterise that figure as a best guess?
Sir Robert Stheeman: It is a best guess, yes. As I say, there are some very clever people in the Treasury who have looked at these numbers carefully. They would probably dispute the £1 billion. It is not a bad guess, but it is a best guess.
Wes Streeting: There is that health warning, which you have very helpfully set out this afternoon. Thank you very much.
Q33 Colin Clark: Given that the Debt Management Office has responsibility for the management of the Public Works Loan Board, what level of oversight does the DMO have for the public works-issued loans?
Sir Robert Stheeman: Perhaps I can turn to my colleague Jo on this one, as you have probably heard enough from me, to give Jo the chance to respond to this and perhaps explain what we do there, in terms of PWLB.
Jo Whelan: The Public Works Loan Board is a statutory body that is housed within the DMO. You may know that it dates back to the Victorian era. Nowadays it is really an operational function. Our role is in administering the process of loans being applied for, the moneys being passed out, the records being kept and the repayments being collected. The source of the funds is from the national loans fund, which is an account under the responsibility of the Treasury. The Treasury also has a role in relation to the rates that are applied to the loans. Again, we administer that for it, but the methodology is owned by the Treasury. The Treasury, if you like, creates a lending policy framework within which we administer the function and, more broadly, oversight of the relationship between central Government and local government lies with the Ministry of Housing, Communities and Local Government.
Q34 Colin Clark: On that point, is there any restriction on how much the public works can loan to local authorities? What role do you play in that?
Jo Whelan: Yes, there is. There is a statutory restriction, which is created under statutory instruments from the National Loans Act 1968. Currently, £85 billion is the maximum aggregate outstanding that is permitted.
Q35 Colin Clark: How do individual councils calculate that?
Jo Whelan: There are no specific limits at an individual council level. If I can briefly explain, there are two general approaches applicable to local authorities. Minor local authorities have to get permission from Government for every individual piece of borrowing they do. Major local authorities—the counties, unitaries and so on—have devolved powers to decide what is prudent, sustainable and affordable for them to borrow. That is done at that local level. The process we have is enabling local authorities that have independently arrived at what they think is the right thing to do to access the economies of scale that central Government achieve in the financing markets.
Q36 Colin Clark: I was briefly a councillor. I was always curious what oversight there was over the council making the decision of what was prudent. Prudent to me, having a business background, I found very difficult.
Jo Whelan: Since 2004, the arrangement for major local authorities has been governed by the prudential regime. There is a statutory responsibility on the council, mainly through the body of the section 151 officer, who is the head of finance, to have regard to the prudential code, which is set out by the professional body CIPFA. Statutory guidance is issued by the Ministry of Housing, Communities and Local Government. That requires them to determine what are prudent, affordable and sustainable. There is some guidance given on that. I must confess that we are not the experts on that, but that is the broad framework.
Q37 Colin Clark: It has been well reported that almost £4.1 billion of public works loans have been used to fund commercial property acquisitions. Does the DMO have a risk profile for these investments? Is that your task?
Jo Whelan: It is not our task at all, no. As I said, for these major local authorities where their responsibility is devolved, they are under no obligation to tell us what their purposes are in coming to us to borrow.
Q38 Colin Clark: You would not know what proportion is high risk.
Jo Whelan: We do not hold any records on that. We do not collect that. That is not part of the process. The process is designed to give full rein to the devolution that was intended by Parliament.
Q39 Colin Clark: So that I understand this, if the DMO is ultimately responsible for the management of public works loans, why do you not have a risk profile? Where does the statutory responsibility lie?
Jo Whelan: Our role is in making sure the money is safeguarded, in that it is going to the appropriate bank account, it has been collected on time and that kind of thing.
Sir Robert Stheeman: It is purely operational.
Q40 Colin Clark: You are not making the creditworthiness.
Jo Whelan: No.
Sir Robert Stheeman: To emphasise Jo’s point on that, we are effectively, for want of a better description, a non-discretionary lender. We are a non-discretionary lender on account of the legislative and policy framework under which we operate.
Jo Whelan: Yes. Before 2004 it was a different system; there was a system of quotas. Local authorities had to negotiate those with central Government. The PWLB of that era then administered that process. Since 2004 it has been this devolved arrangement.
Q41 Colin Clark: In November 2016 the Government indicated their intention to transfer the functions of the public works to Her Majesty’s Treasury. Why do you think they made that decision? On some of the points we have gone over, if they bring it in house, will there be more oversight?
Jo Whelan: The reason for that was that the governance framework for the statutory body, as I said, dates back to the Victorian era and is really out of keeping with modern governance arrangements. The intention in doing the transfer of functions is just to modernise the governance. For example, by bringing it formally into the Treasury, it allows the usual accounting officer-type structures to be put in place, which at the moment are not possible because everything is couched in Victorian terms. It is not the intention to change the policy. The policy overall will be shaped by what central Government’s intended relationship with local government is. If devolution continues to be the situation, the policy will stay as now.
Q42 Colin Clark: On the point you made, Sir Robert, of being a non-discretionary lender, if it goes back inside the Treasury, would the Treasury take a different perspective? Ms Whelan, you were speaking about the discretion and that they are not planning to change policy but, if it goes back inside the Treasury, will there be a difference?
Sir Robert Stheeman: Ultimately, it is a question probably for the Treasury and the Ministry of Housing, Communities and Local Government, and how they want to manage that. That is really a policy decision. I will add to Jo’s point. We talk about the Victorian architecture. There are in theory 12 commissioners appointed by the Queen who, purely unremunerated, are decent enough to give up their time to be able to do very little. That construct bears no relevance to what they are asked to do. We have to go through the rigmarole of trying to make sure they get appointed and finding people who are willing to do this. Yet how often do they formally meet?
Jo Whelan: They meet once a year.
Sir Robert Stheeman: It is tidying up something that does not feel in its structure—
Q43 Colin Clark: It is time to modernise.
Sir Robert Stheeman: Yes.
Q44 John Mann: My questions relate to a timespan of the life expectancy of this Parliament, so three years almost exactly. What should happen with QE?
Sir Robert Stheeman: QE is ultimately a monetary policy decision, and what happens with it is one for the MPC and the monetary policy authorities. That is the obvious answer that I have to give. I think behind your question—stop me if I am wrong—is a question about what should happen to the gilts that the Bank perhaps has on its portfolio. The Bank has been clear in its most recent communication on the topic. The MPC has said it will not look to start reducing the stock of gilts in the asset purchase facility until the bank rate reaches 1.5%. That is what it has said most recently.
Q45 John Mann: What advice have you been asked to give?
Sir Robert Stheeman: We talk closely to the Bank about this. The Bank of England Governor himself has made it explicitly clear that, when it comes to selling, the decision to sell will be theirs and must be theirs. That is a monetary policy decision. When it comes to the question of how they might choose to sell, we have spoken to them about that and they have been explicitly clear that there will be co‑ordination with the DMO on that.
Q46 John Mann: What are the implications for you if there is no unwinding in the next three years?
Sir Robert Stheeman: We will presumably carry on as we have for the last 10 years where QE has existed, if there is no unwinding. The big issues for us, of course, will be when that unwinding occurs because, in the period where QE was implemented, you had us on one side of the market issuing, the market in the middle and the Bank on the other side buying. The Bank had been reinvesting the proceeds of maturing gilts and coupons a little bit, but that has stopped. At the moment, the Bank is doing nothing. If the Bank continues to do nothing, as now, we will continue with our issuance.
Q47 John Mann: What are the implications for you if there is unwinding over the next three years?
Sir Robert Stheeman: That is where we will have to talk carefully, because then we would both be on the same side of the market: we would be selling—we have to—and they would like to sell. The Bank has made it explicitly clear that the authorities do not want to see anything that leads to disruption in the market. That is the stated intention. You do not have a guarantee that we can ensure that occurs, but we will talk to them very closely. They have said that their sales will be conducted in a programmatic fashion. There will be issues we will have to sort out with them. For instance, we have an auction calendar that we set out one year in advance.
Q48 John Mann: There will have to be market implications for you.
Sir Robert Stheeman: There will be.
Q49 John Mann: What are they going to be? That is my question.
Sir Robert Stheeman: Higher yields. That could be deliberate on the part of the MPC. If you believe that QE has led to a reduction in gilt yields, and virtually everybody does, if they start to sell, you will see higher gilt yields and a higher cost of Government borrowing.
Q50 John Mann: If nothing is ever done with QE, is that a concern?
Sir Robert Stheeman: QE was regarded as—I think this was the phrase used—extraordinary monetary policy. If nothing is done with it, the extraordinary begins to look quite ordinary. It begins to look semi‑permanent. There is a wider debate, which I have to say is not one for the little DMO, on whether QE has become some kind of a permanent monetary policy tool. That is, as I say, one for the central bank and one for the Treasury. Over time, if nothing happens to that portfolio or if, for instance, maturing gilts are allowed to run off and not be replaced, as is currently [not][3] the case, you would see the stock of QE reduce and the effect on us would be correspondingly small.
Q51 John Mann: I have maybe two final questions. What have you learnt from the American experience in this regard, and how is that influencing the advice you have been giving in terms of your remit when talking to the Treasury?
Sir Robert Stheeman: As for what the Americans have done, you can see a bit what has happened, because they have begun to, as they call it, taper and unwind. They are looking very carefully at the way their stock of US treasuries is maturing throughout the year—coupons—and how they are reinvested or not in the market. It becomes quite a technical thing; the sort of thing that interests us and we would talk to the Bank of England about. Whether the Bank chooses to follow exactly what has happened in the US is another matter. The markets are different. Whatever is decided, and it is ultimately an MPC decision, would have to be suitable for the gilt market, in terms of unwind.
Q52 John Mann: I have a slightly different question on the same theme. This Committee has a very specific role in relation to the appointment of the next Governor of the Bank of England. That process is already slowly, or perhaps not slowly, underway. What would your advice be from the perspective of your organisation to this Committee in what the best approach ought to be by the next Governor of the Bank of England when we are interviewing, in essence, to see whether the appropriate person is getting the job? Is QE really that important in the context of the perspectives of the next Governor, from where you are sitting, in terms of your responsibilities?
Sir Robert Stheeman: Golly. I can give you what has to be a personal opinion, because it is mercifully not my choice. QE, as I indicated a moment ago, has become almost part of the monetary policy landscape. My personal advice would be to think very carefully about whether you really want that to continue. Is it something you want to keep back in reserve for emergencies, as occurred 10 years ago? Is it something you fundamentally feel you want to constantly have, so an extra tool you want to give the monetary policy authorities? I really want to emphasise that this is a personal opinion. There is a debate—not just confined to this country but one that needs to happen in other countries, in the US and in Europe—about the role of the central bank’s balance sheet and how it wants to use that balance sheet to influence monetary policy. Do they want gilts, Government bonds, to be a fundamental tool or not? That is ultimately a decision not just for the bank, but for the Government of the day and for Parliament. That is the first thing.
Directly in answer to the first part of your question, anyone appointed to the position of Governor, as is the case and as happens at the moment, needs to think about these things very carefully and will need to ensure that the dialogue that exists between the DMO and colleagues in the Bank on operational matters to do with a potential QE unwind is maintained. Everybody has indicated they want that dialogue to be maintained.
Q53 John Mann: I am not trying to unduly put you on the spot. To more easily get where you are coming from, do you think it would be wise for this Committee to be giving a lot of consideration to the future of QE over the period before the appointment of the next Governor, so over the remainder of this year, so that any view we might have or not have on it, should there be a strong consensus here, is out in the public domain earlier rather than later?
Sir Robert Stheeman: Because I work at the DMO and gilts are what we do, I would answer that with a clear yes, but I would also, I hope, have the wider picture, in that it is one of a number of factors you are going to have to take into account. It is just one. From where I sit, it is very central.
Q54 Chair: It has been a fascinating session on what you do as a DMO, but we are also interested in how you do it as a DMO. These might be more questions for Mr Juffs. We have done a lot of work about women in finance and we have asked the Treasury’s permanent secretary and the Chancellor about the balance of men and women in the Treasury. It is worth noting that, within the Treasury group of agencies, the DMO has a gender balance of 63% men to 37% women. Is there a particular reason for that? Is it something about the DMO or the work that you have found has affected recruitment?
Sir Robert Stheeman: That is absolutely right. To talk about the staffing—Jim might jump in here—for us, a key issue is the environment in which we operate. We are physically located in the City. Well over 90% of everybody we recruit at the DMO comes from the private sector. To some extent, although I will also say that our diversity numbers are significantly better than the private sector, those numbers reflect the environment in which we have to operate.
Q55 Chair: On the gender pay gap, I know you do not have to declare it as such, but that might be something you have done some work on.
Jim Juffs: Yes, indeed. Sir Robert is absolutely correct. Our commitment is to be a completely equal employer. At the same time, we have an operational mandate, we have to get people into seats and we have to have a wide range of skills, from dealers, risk managers and accountants to technology people. Underpinning that is that commitment to equality. In terms of our own pay gap statistics, we are part of the Treasury’s numbers and, because we are a small organisation of less than 250, we do not have to publish individually. Our statistic in terms of pay gap is a pay gap of 13.5% in 2017-18. The Treasury is a bit lower than that.
There are a number of issues about the DMO that might make a difference. First, we are only a small organisation. When the statistics are taken, they are taken as a snapshot at year end. It very much depends on who was in post at that particular point. That is one issue. The other one is that it depends on leavers. Whoever leaves during the year can affect our statistics disproportionately. Joiners cannot join the statistics until a year after they join. We are slightly dependent on how the mechanics work.
Having said that, we are fully committed to doing what we can to address that going forward. In fact, some of the things we have been thinking about offline are to try to encourage more women to apply to the DMO. More generally, our recruitment has not been always wholly successful. That is not just about particular types of representation; it has been more about whether we can anybody with the relevant skills at the relevant price into the DMO to do the job we want from them. As a small organisation in the public sector competing for resources with the financial markets, we do not have all the tools in our armoury to deliver the package that the outside world can give. Nevertheless, that commitment is there.
Q56 Chair: A number of organisations in the City, but also the Bank of England and others, would say similar things. Part of this is knowing what the number is and then having a programme, as you say, to address it. Is this something that has been raised with you by the Treasury? Is it in your senior management discussions as an agenda item?
Sir Robert Stheeman: It is, certainly in the senior management discussions. We have a very clear commitment to that. To give you an example—and this is not easy for a small operational entity—we have 10 people who work part time in the DMO. That is just under 10% of total permanent staff. Nine of them are women. One of the reasons is that part-time working often appeals to women. We are very glad and happy to support that. Where we can, we do what we can, but we have limits. The City is a very male environment. That is a fact. When we sit around every quarter in formal consultation meetings with our gilt-edged market makers, it is surprising if there is one lady present from the gilt-edged market maker group. That is out of 15. It is quite surprising. It can happen and it does happen, but there is usually not more than one.
We have to do what we can, but we are also constrained by where we recruit. In terms of the Treasury, Jim has said that our numbers feed into the Treasury’s own statistics, which is to some extent not fair to the Treasury because, for a policy-making organisation rather than a City operational entity, it is probably able to and does have better gender pay statistics than we do. To some extent, they probably feel—and I have spoken to Tom Scholar about this—that our numbers at the margin mess up their own numbers.
Q57 Chair: They could publish separately. They could publish the overall Treasury number and the different agencies as well, as a breakdown, to explain.
Sir Robert Stheeman: They could. If that were to happen, that would be fair from the Treasury’s perspective, but I would advise extreme caution in looking at our numbers too closely, exactly for the reasons that Jim said. I would focus on our policies and what we do to support diversity. If you look at the numbers in a small organisation, you just need one or two things. One of the reasons that our numbers are not that bad and vastly better than most of the financial sector is that, on what we call our executive board, for more than 10 years now, we have always had parity: two women and two men. That is a great thing. Genuinely, I believe it is a great thing but, if one of the ladies were no longer to be there, that would significantly and automatically, if she were replaced by the man, affect the numbers. That can have a huge impact on a small organisation.
Q58 Chair: There is a broader argument about the size of organisations. Finally, you mentioned that about 90% of your recruitment comes from the private sector. We touched on Brexit earlier on but, in relation to the impact on skills and recruitment, as you say, a number of the people you are drawing from are quite specialist. If some of the functions that I presume they are currently doing in London were to be moved overseas to deal with Brexit, what would that do? How many EU nationals do you have already in the organisation? In the market you are recruiting from, do they tend to be quite an international part of the skills market in London? Jim, you are nodding.
Jim Juffs: That is right. They do. In fact, in our recruitment, we had 13 last year, and we get quite a lot of overseas interest. We have 10 people from the EU currently on the staff and we are in discussion with them about how they feel about the future. We are very much into getting the best people we can, irrespective of whatever dimension they come from. We have also had one or two people who have left since the referendum.
Q59 Chair: Because of the uncertainty?
Jim Juffs: Because of the uncertainty more than anything else. A positive picture is that we have 10 who have chosen to stay. We will do everything we can to retain them.
Sir Robert Stheeman: With two, we have used—what is it called?—the Government’s thing that allows them to get settled status.
Q60 Chair: You are helping them to go through that process as employers.
Sir Robert Stheeman: Yes, we are.
Chair: Thank you very much indeed. I do not think we will leave it so long next time. It has been a very interesting session to find out about the work and get your perspective on a number of issues, not least one of the questions that may well be in the next Bank of England Governor’s questionnaire. Thank you all very much indeed for your time this afternoon.