Gilts: no more temporary WI security

Julian D. A. Wiseman

Abstract: the DMO has scrapped the creation of a temporary WI security, as was recommended on jdawiseman.com some 8⅓ years before.

Publication history: only at www.jdawiseman.com/papers/finmkts/20150203_when_issued.html. Usual disclaimer and copyright terms apply.

Gilts: no more temporary WI security

From the DMO announcement on 29^th January 2015 entitled DMO Technical Notice: Notice of Intended Procedural Changes in "When-Issued" Trading for Gilts (local copy):

… a future change to … the trading of UK Government Bonds (gilts) ahead of an auction, where the stock being auctioned is a re-opening of an existing line of gilts with a pre-existing ISIN code, and where the auction bonds become immediately fungible with their parent bonds upon issue and first settlement date.

The DMO will no longer be declaring a "When Issued" (WI) trading period … for such re-openings, nor will it be issuing a separate WI ISIN code for new tranches of existing gilts. In addition, Gilt-Edged Market Maker firms will no longer be obliged to submit closing prices in such bonds.

An excellent decision. Indeed, exactly the same decision as was recommended on jdawiseman.com in September 2006, being 8⅓ years prior, in an essay entitled Bonds: too many; too small:

… for a re-opening of an existing gilt, the UK actually creates a new ‘WI’ security with its own ISIN, and has that new security merge with the old almost immediately after the auction. … it is inadvisable: other debt managers should not do likewise. The only circumstance under which this new-security-and-merge process would be different to a true re-opening is if the auction were cancelled. But market participants treat trades in the WI as being equivalent to trades in the old security for settlement after the auction. Nobody manages this WI-versus-old risk. Nobody measures it. It seems that almost nobody thinks about it. So why has the DMO (and the BoE before it) left this submerged log lying about in harbour? At best, it is harmless. But it could be an accident waiting to be discovered at a time—cancelled auction—when the authorities will have more than enough else to do. Presumably the market makers will think about this risk when the Financial Services Authority asks them how they measure it, at which time they will ask the DMO to stop this needless complication.

So an excellent decision. And, even better, taken before being bitten by not taking it.

Indeed, for the little that it is worth, my first mention of this problem was in a letter to the Bank of England dated 30^th June 1997 (so 17.6 years prior), on the subject of ISIN codes for STRIPs:

… Perhaps the authorities should consider a slight change of policy, and reopen the existing gilt (which will therefore have the same codes), rather than create a new gilt that subsequently funges.

I realise that this would necessitate a change to the conditional nature of WI trading. But this conditional nature is exactly the sort of very rarely exercised legal bomb that exaggerates the systemic risk in financial systems. Few people know that a forward trade in the old stock is materially different to a WI trade (I didn’t before today), and none of the hedges are conditional. As a matter of prudent risk-averse policy, the Bank should avoid such a trap in financial systems. This provides another motivation to issue into the secondary market — although strips could act as the trigger. It might be that WI rules will still be necessary for auctions of new stocks — but for administrative reasons we hope that the Bank can avoid a complete set of duplicate WI coupon strips.

This was not quite my longest-outstanding suggestion to the authorities.