The issuance (primary) and subsequent trading of government bonds (secondary) are usually seen as capital market activities. On the capital market financial products with a maturity of at least one year are traded.
Image: Outlook 2016
Dutch State Loans
In order to satisfy its funding needs, the Dutch State issues bonds, known in the market as Dutch State Loans (DSLs). The holder of the bond is a creditor of the State. The State has the obligation to pay the coupons and to redeem the principal of the bond.
DSLs have a fixed maturity. For example, every year a new bond with a maturity of 10 years is issued. The day the bond will be redeemed is fixed in time and the holder of the bond receives an annual coupon. Coupon payments on the 10-year bond always take place on 15 July. The name ‘coupon’ goes back to a time when bonds consisted of a main sheet and detachable coupons that could be presented annually to claim payment of the interest. Today, interest payments take place electronically, but the notion of coupons has survived. On the maturity date of the bond, the last remaining coupon and the notional amount are redeemed by the DSTA.
The most important characteristic of DSLs is their creditworthiness. The Dutch State has the highest rating (AAA) and guarantees full and timely payments of coupons and redemptions. In financial markets, the Dutch State is traditionally recognised as one of the most secure and creditworthy debtors. Every credit rating for the Netherlands provided by a credit rating agency (CRA) is unsolicited. CRAs base their ratings on publicly available information on government policy and government finances. CRAs provide at least “country ratings” for the Netherlands; some also provide individual “bond ratings” of DSLs. The State of the Netherlands issues only senior unsecured debt. Although investors should always independently establish whether a specific financial instrument is appropriate for their investment goals, the DSTA is of the opinion that individual bonds would rate equal to the country rating for the Netherlands.
In March 2012 the DSTA introduced permanent buyback facility for DSLs. The goal of this facility is to improve the DSTA’s cash management. Currently the DSTA can buy back DSLs that mature within a period of up to T+24 months, which enables it to manage its cash position more effectively and to adjust its redemption profile for the next 24 months.
Buybacks are done bilaterally with Primary Dealers; the extent to which the secondary market is entered is determined on a day-by-day basis. To ensure liquidity of the eligible bonds, the DSTA continues to commit itself to a minimum outstanding volume of every DSL of at least € 10 billion. DSLs that have been bought back are cancelled immediately.
The process of trading the coupon of a bond seperately from the principal (or body) is known as 'stripping’. The resulting products are referred to as 'STRIPS' (Seperate Trading of Registered Interest and Principal Securities). All Dutch bonds are strippable.
Stripping a bond generates seperate cash flows: a series of annual coupon payments and the single redemption at maturity. Acquiring seperate cash flows might be interesting for investors who want to match liabilities at a specific time in the future, without being confronted with reinvestment risk in the meantime due to coupon payments. Furthermore, STRIPS can be an appropriate instrument to adjust an investment portfolio.
STRIPS, just like bonds, are subject to the Dutch law on securities. The procedure for settlement and payment of the coupons and redemptions is equal to that of regular bonds. Trades in STRIPS take place on Euronext among other platforms.