Changes to cash management operations
The Government agreed with the Bank of England to transfer to the Exchequer the excess cash held in the Bank's Quantitative Easing facility.
On 9 November 2012 the Government agreed with the Bank of England to transfer to the Exchequer the excess cash held in the Bank’s Quantitative Easing (QE) facility.
This will align the cash management arrangements for the facility with normal government practice and with the approach followed by other countries undertaking QE. On the 9 November 2012 the Chancellor of the Exchequer and the Governor of the Bank of England exchanged letters agreeing the cash management arrangements.
Since 2009 the Bank of England has operated QE by buying gilts and holding them in a dedicated facility called the Asset Purchase Facility (APF). These gilts attract regular coupon payments from the Exchequer. With the purchases of the APF having reached £375 billion, this Facility has now accumulated a large cash balance. As the scale and likely duration of the scheme has increased significantly since its inception, it makes sense to normalise the cash management arrangements for the APF.
From now on this excess cash will be transferred to the Exchequer on a regular basis. This will improve transparency and align our practices with those of major central banks like the United States Federal Reserve and the Bank of Japan.
These changes will end the current arrangement which requires the Government to borrow money to fund coupon payments to the Bank of England. Holding large amounts of cash in the APF is economically inefficient as it requires the Government to borrow money to fund these coupon payments.
At some point in the future, as monetary conditions normalise, it is likely that the cash flows will need to be reversed. Return payments from the Government to the APF may be necessary to meet shortfalls in the APF’s net income as the Bank Rate rises, or capital losses on its gilt holdings as the Monetary Policy Committee unwinds QE. The previous Government agreed that any future losses incurred by the APF will be met in full by the Government. For this reason, any net coupon income transferred from the APF to the Exchequer should be used solely to pay down government debt.
These changes will have no effect on the Monetary Policy Committee’s ability to set monetary policy: the APF remains fully indemnified by the Treasury and all future gains or losses are due to the Treasury.
Notes for Editors
Background
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The Bank of England Asset Purchase Facility Fund (APF) is a subsidiary of the Bank of England which is used to carry out Quantitative Easing (QE) through asset purchases, funded by the creation of central bank reserves. The Monetary Policy Committee (MPC) decides on the level and pace of asset purchases through the APF as part of its monetary policy operations. As of 8 November, the APF has purchased £375 billion of gilts. The APF has now been operating for longer, and over a larger scale than the original limit of £150 billion. As a result the APF has accumulated a significant cash surplus. The Treasury annual report and accounts (July 2012) set out that the APF had accumulated £23.8 billion of excess cash (largely from coupon repayments).The cash held in the APF is expected to increase to around £35 billion by the end of March 2013 (based on the amount of gilts purchased remaining at £375 billion).
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This cash largely represents the accumulated coupon payments from the Government to the APF on its gilt holdings (the APF has also made a small profit on the sales of its private sector asset holdings and receives interest on its cash balance). As the APF’s operations are fully indemnified by HM Treasury, any surplus or deficit from the APF’s operations is due to the Exchequer, and is recorded as a derivative asset or liability on HM Treasury’s balance sheet.
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The APF is financed by a loan from the Bank of England, and the APF pays interest on its loan. All cash accumulated in the APF will be net of these interest payments and other expenses.
Rationale for transferring excess cash from the APF
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The excess cash from the APF will now be transferred to the Exchequer on a regular basis.
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Transferring the cash back to the Exchequer will allow the Government to manage its cash more efficiently. This action will bring these arrangements into line with standard cash management practices for government activities, and is also in line with other major central bank practices. For example the Federal Reserve’s QE programme is conducted via its usual open market operations and all residual earnings from the Federal Reserve are distributed to the Treasury. The Bank of Japan also pays the government its entire net income, including from its government bond purchases, after deducting expenses and income taxes.
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Any cash flow received by the Government now in terms of coupon transferred to the Exchequer must be viewed in the context of future payments by Government under the indemnity. For that reason, cash transferred from the APF to the Exchequer will be used to benefit the public finances and to reduce debt.
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As noted above, the operations of the APF are fully indemnified by HM Treasury with any gains or losses falling due to the Treasury. At present the APF is in overall profit (reflecting both cash holdings and mark-to-market gains on the gilts held by the APF) and this is recognised as a derivative asset on the Treasury’s balance sheet (that is, the best estimate of the asset’s value). Transferring the cash will reduce the value of the derivative asset held by the Treasury. However there is no intention to transfer any sum that represents the mark-to-market gain from movements in gilt prices as these are volatile and subject to reversal.
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At some stage the MPC may decide to tighten monetary conditions and increase the Bank Rate. This will act to reduce net interest receipts in the APF by increasing interest paid to the Bank of England. As part of the process of tightening monetary policy, the MPC may decide to sell part or all of its gilt portfolio over time. As gilts are sold or redeemed, it is likely that the proceeds will be lower than the original purchase price (if gilt yields are higher and gilt prices lower than at the time of purchase). And if gilts were held to redemption rather than being sold, the redemption value is likely to be lower than the purchase price paid by the APF, since most of the gilts were purchased above par. The coupon income received by the APF in part compensates for these expected capital losses. Return payments from the Government to the APF may be therefore be necessary to meet shortfalls in the APF’s net income as Bank Rate rises, or capital losses on its gilt holdings as the Monetary Policy Committee unwinds QE. The Treasury will then make regular cash payments back to the Bank consistent with the terms of the indemnity.
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There is no intention to make cash payments to meet mark-to-market losses on the APF portfolio that may occur due to movements in gilt prices. However this process ensures that when the APF portfolio is eventually wound down any losses are met in a smooth fashion so that there should be no large outstanding amount for the Treasury to pay to meet the terms of the indemnity at the end.
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Continuing to accumulate cash in the APF now to offset these possible future claims would represent inefficient cash management. The potential future liability is uncertain in size and timing. The Government does not normally pre-fund its future contingent liabilities.
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This normalisation of the cash management process has no practical implications for the ability of the MPC to expand or reduce the stock of gilts held by the APF in order to loosen or tighten monetary policy.
Transfer Arrangements and Fiscal Impact
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If the APF’s gilt purchases remain at £375 billion, it is expected that around £35 billion of excess cash will have accumulated in the APF by the end of 2012-13. In order to maintain the stability and predictability of the Exchequer’s cash management operations, the transfer of this cash to the Exchequer will be staggered across 2012-13 and 2013-14 as follows.
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It is envisaged that the net coupon income earned by the APF during 2012-13, expected to be around £11 billion, will be transferred to the Exchequer during 2012-13. The excess cash that had accumulated in the APF up to the end of 2011-12 (£23.8 billion) will be drawn down over the course of 2013-14.
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From 2013-14, the ongoing cash surplus will be transferred regularly on a quarterly basis thereafter. The cash surplus will be transferred to the Exchequer net of a buffer that will consist of;
- interest payments due from the APF to the Bank of England with respect to any loan advanced by the Bank to the APF
- the APF’s operating costs
- the management fee charged by the Bank
- for any gilts that are due to mature over the quarter, the difference between the redemption price and the original purchase price of the gilt. This will enable the MPC to maintain the overall size of QE through reinvestment, if it wishes to do so. This does not pre-empt any MPC decision on reinvestment.
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All of these cash transfers are expected to impact on the Central Government Net Cash Requirement. The Office for National Statistics will decide on the classification of these flows and thus their impacts on fiscal aggregates, while the Office for Budget Responsibility (OBR) will forecast future impacts. As is usual, the Debt Management Office’s financing remit for 2012-13 will be revised at the time of the Autumn Statement to reflect the OBR’s latest fiscal forecasts.
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As noted above, it is likely that the APF may in future incur capital losses on the sale or redemption of its gilt holdings. The Exchequer will make payments to the APF as these losses arise, on a regular quarterly basis.