In its daily operations as a debt manager, the DSTA faces a number of risks, such as interest rate risk, credit risk, foreign exchange risk, concentration risk, settlement risk, legal risk and operational risk. How the DSTA manages a number of these risks is discussed below.

Parlementsgebouwen en skyline van Den Haag

Skyline of the Hague

Image: Outlook 2014

Interest rate risk

One of the aims of the DSTA is to finance the public debt at the lowest possible cost, with an acceptable risk for the budget. The main risk for the budget is interest rate risk, which is the risk that interest costs vary due to fluctuations in the market. This risk is managed by an interest rate risk framework which is revisited every four years. 

The risk for the budget is minimized when the interest rates on the public debt are fixed for as long as possible. In this way the interest costs are as stable and as certain as possible. However, the longer the interest rates are fixed, the higher the interest costs will be in general. Therefore, a balance has to be found between risk and costs. In the risk framework for the period 2008-2015 this balance was thought to be optimal when the interest rate was continuously fixed for a seven year period (resulting in an average maturity of 3.5 years at any point in time). In order to reach this desired risk, the DSTA used interest rate swaps.

Since 2012 it has become possible to deviate from what became known as the 7-year benchmark, to react to the historic low interest rates. The deviation implied that the interest rate period of long term state bonds no longer had to be swapped back to 7 years, implying less reliance on interest rate swaps. This caused a gradual increase in the maturity of the portfolio compared to the 7-year benchmark. A more extensive description of the 7-year benchmark and the deviations that were allowed can be found in chapter 4 of the 2012 Outlook.

In 2016 a new interest rate risk framework was put into place in order to further increase the maturity of the debt portfolio (including swaps). The change was driven by the current low interest rates, as this implies that the costs of increasing the date of maturity are relatively low. At the same time, however, these exceptional low interest lead to an increase of the interest rate risk. Under the conditions that in the new risk framework the risk is not higher than in the previous framework and that the new risk framework is less dependent on interest rate swaps, a new assessment of the balance between risk and costs has led to a new desired average maturity of the portfolio (debt and swaps) of 6.4 years. 

The average maturity of the portfolio at the end of 2017 was 6.0 years. For the years up to 2019 the maturity should meet a path of predetermined values, which will lead to a maturity of 6.4 years at the end of 2019. This path is communicated in the 2016 Outlook.

The average maturity is a measure of the long term interest rate risk. To manage the short term risk an additional measure has been introduced: the refixing amount. The refixing amount reflects the nominal amount of debt and swaps for which interest rates have to be refixed within the next twelve months. For 2016-2019 the refixing amount will be maximised at 18% of the total public debt.

From 2016-2019 the financing and risk policies will aim at an average maturity and a refixing refinancing amount that satisfy the above mentioned conditions. Instruments that can be used for that purpose are bond buybacks, a certain amount of flexibility in the issuance on capital markets, and adjustments to the swap portfolio.

Credit risk

Credit risk is the risk of loss due to a debtor’s non-(re)payment of its contractual obligations. The DSTA is exposed to credit risk when depositing cash with counterparties. To minimize this risk counterparties have to comply with strict requirements regarding their creditworthiness, such as a minimal level of their credit ratings. Furthermore, credit risk is restricted by minimizing uncollateralized deposits and by limiting cash deposits for longer periods.  Buy-sell-back transactions (reverse repo’s) are the preferred instrument, since collateral is provided to the DSTA. If a counterparty is not able to fulfill its contractual obligations, the DSTA can use the collateral to cover the loss. In response to the credit crisis, the DSTA decided to strengthening the rules to mitigate credit risk. To illustrate, uncollateralized deposits are only allowed for overnight transactions. The DSTA also engages in transactions with Debt Management Offices from a number of different countries on a regular basis.

When concluding interest rate and foreign exchange swaps, the DSTA is also exposed to credit risk. Therefore, swaps can only be concluded with Primary Dealers and Single Market Specialists that meet minimum requirements of creditworthiness and with whom an ISDA agreement (International Swap & Derivative Association) including a CSA (Credit Support Annex) is signed. During the maturity of a swap transaction, the counterparty is obliged to post collateral with the DSTA if the market value of the swap – which is monitored on a daily basis - is positive for the DSTA. The Dutch State does not post collateral with counterparties.

Concentration risk

Concentration risk can be defined as the probability of loss arising from heavily lopsided exposure to one or a small group of counterparties. The DSTA manages concentration risk by setting maximum credit limits on the exposure vis-à-vis individual counterparties. This limit determines how much and by means of which instruments money can be put with a certain counterparty. The limit depends on the creditworthiness and size of the counterparty.

Foreign exchange risk

In addition to issuance in euro, the DSTA also issues in foreign currencies. Commercial Paper is issued in euros, US dollars, British pounds and Swiss francs. In 2012 the DSTA also issued two US dollar denominated bonds.

All issues in foreign currencies are swapped to euros, to safeguard the DSTA against foreign exchange risk. As a result, the funding costs in euros are fixed when the transaction in foreign currency is executed.