UNCTAD Virtual Institute for Trade and Development
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Sovereign Asset and Liability Management: An E-Learning Training Course
I. Institutional Setting
II.Asset and Liability Management Office
III.Debt Management Office
IV. Potential Conflicts of Interest Between the Central Government and Central Bank

Debt Management Office

The DMO will likely be tasked with SALM if there is not a separate ALMO to serve this function.  In instances where SALM is applied by the DMO, incorporating effective debt management policy while also managing risk across the broader government balance sheet will be challenging.  “In order to enhance coordination and communication mechanisms among the different departments, special units/bodies dedicated to SALM can be established within the DMOs” (Koc, 2014).

“One of the key organizational issues is to decide how broad the responsibilities of government debt managers should be in managing parts of the government’s balance sheet.  At a minimum, government debt managers need to have policy responsibility for managing the domestic and foreign currency debt of the central government, even if some of the implementation is contracted out to the CB.  But difficult issues can arise in deciding whether to extend government debt managers’ mandate to funding and managing risks associated with the government’s investment in SOE’s, particularly those with commercial objectives, and whether debt managers’ role should include monitoring and managing risk relating to the government’s CL” (Wheeler, 2004).

“The first issue that must be addressed for SALM within the DMO is which responsibilities will be given to the DMO itself and the debt manager. Will the focus be on liabilities, namely the composition of the debt portfolio, and to what extent will the debt manager have input and responsibility regarding decisions about assets and their management?  There is evidence to suggest that since the primary responsibility of the DMO is to manage the debt portfolio and is the main criteria used in assessing the performance of the DMO and debt manager, the DMO may focus on minimizing borrowing costs. This can result in a debt portfolio with an excessive amount of domestic short-term domestic debt that increases refinancing risk and ignores the impact of this policy on the rest of the asset and liability portfolio as a whole.  Emerging economies with undeveloped capital markets are especially vulnerable to this practice.  The inability to borrow in the local currency long-term (original sin) creates incentives for the debt manager to borrow in short-term maturities in the domestic currency as this is often the cheapest source of financing.  Efficient management of the external risk exposure of sovereign liabilities requires institutional arrangements that provide incentive structures for debt management, technical expertise and sophisticated information systems, and strict internal management procedures” (Cassard and Landau, 1997).

“The management of assets by the DMO should reflect the same risk tolerance as the composition and management of liabilities. As discussed in Module I and in the literature, governments are generally risk averse and prefer to forego potential gains in favor of avoiding large losses.  If the DMO is entrusted with the management of assets, it must incorporate the same risk tolerance it has for liabilities.  A greater appetite for risk could be manifested in, for instance, speculative investments with energy exploration or joint ventures in high-risk activities with private sector partners. On the debt management front, it could involve tactically trading a liquidity portfolio or basing all borrowing decisions on views about future movements in exchange rates and interest rates” (Wheeler, 2004).

The DMO must formally and decisively determine the framework for coordinating the management of assets and liabilities of not only the central government, but those of the other governmental units if a centralized risk management framework has been adopted.  If a centralized approach has been selected, the DMO may become involved in the asset and liability management of State-Owned Enterprises, Sovereign Wealth Funds, and Sub-National Governmental Units.  This raises the question as to the appropriate relationship between the DMO and these entities.  The advantages that may result from the central government having a prominent role in these entities, may be offset by the perception by these entities themselves and the public at large, that lack of autonomy may distort decisions on the sub-governmental level and ultimately be costly for the central government.  For instance, an SOE may be able to reduce its borrowing costs by accessing the credit rating of the sovereign (i.e. revolving funds), but this could erode the autonomy of the SOE as the central government will become more involved with the operations and decision making of the SOE.  Analyzing systemic risk through balance sheet evaluation is one matter, being involved in operational decisions is another.  Additionally, as relationships between policymakers in each of these entities develop, not only will autonomy be reduced, the potential for corruption will increase as well.

From an operational perspective, the cohesiveness of the front, back, and middle offices will have a large impact on the effectiveness of the SALM framework in a DMO.  Clear delegation of responsibilities for not only the management of liabilities but also assets is imperative for dynamic SALM.  As much of the innovation comes from the front office and risk management from the middle office, a delicate balance between creativity and sound risk management must be reached.  Territorialism must be minimized in order to achieve broader organizational objectives.  This requires the explicit determination of responsibilities within the SALM framework.  As the back office has a large role to play with Treasury functions and clearing, operational efficiency will largely be determined by clearly determined reporting lines and responsibilities.









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