Gilt-edged securities

Gilt-edged securities are bonds issued by some national governments. The term is of British origin, and then referred to the debt securities issued by the Bank of England, whose paper certificates had a gilt (or gilded) edge. Hence, they are known as gilt-edged securities, or gilts for short. Today the term is used in the United Kingdom as well as some Commonwealth nations, such as South Africa and India. However, when reference is made to "gilts", what is generally meant is UK gilts, unless otherwise specified.

Colloquially, the term "gilt-edged" is sometimes used to denote high-grade securities, consequently carrying low yields, as opposed to relatively riskier, below investment-grade securities.

In 2002 the data collected by the British Office for National Statistics revealed that about two-thirds of all UK gilts are held by insurance companies and pension funds.^[1] Since 2009 large quantities of gilts have been created and repurchased by the Bank of England under its policy of quantitative easing, and in recent years overseas investors have also been attracted to gilts by their "safe haven" status.

The term "gilt account" is also a term used by the Reserve Bank of India to refer to a constituent account maintained by a custodian bank for maintenance and servicing of dematerialized government securities owned by a retail customer.^[2]

History

The first fund raising that could be considered a gilt issue was in 1694 when King William III borrowed £1.2m to fund a war with France via the newly created Bank of England. The term "gilt" however would not be used until the late 19th century for these types of debt securities.

This form of government borrowing proved successful and became a common way to fund wars and later infrastructure projects when tax revenue was not sufficient to cover their costs.^[3][4] Many of the early issues were perpetual, having no fixed maturity date. These were issued under various names but were later generally referred to as Consols.

Conventional gilts

These are the simplest form of UK government bond and make up the largest share of UK government debt (30% as of March 2008).^[5] A conventional gilt is a bond issued by the UK government which pays the holder a fixed cash payment (or coupon) every six months until maturity, at which point the holder receives his final coupon payment and the return of the principal.

Coupon rate

Conventional gilts are denoted by their coupon rate and maturity year, e.g. 4¼% Treasury Gilt 2055. The coupon paid on the gilt typically reflects the market rate of interest at the time of issue of the gilt, and indicates the cash payment per £100 that the holder will receive each year in two payments.

Gilt names

Historically, gilt names referred to their purpose of issuance, or signified how a stock had been created, such as 10¼% Conversion Stock 1999; or different names were used for different gilts simply to minimise confusion between them. In more recent times, gilts have been generally named Treasury Stocks. Since 2005-2006, all new issues of gilts have been called Treasury Gilts.

Trends

The most noticeable trends in the gilt market in recent years have been:

• a substantial and persistent decline in market yields as the currency has stabilised compared to the 1970s and more recently UK gilts are seen as a safe haven compared to certain other government bonds
• a decline in coupons: several gilts were issued in the 1970s with coupons of around 15% per annum, but these have now matured
• a large and prolonged increase in the overall volume of issuance as the Public Sector Borrowing Requirement has increased.
• an increase in the volume of issuance of very long dated gilts to respond to demand for these.
• a large volume of gilts have been repurchased by central government under its quantitative easing programme

Index-linked gilts

These account for around a quarter of UK government debt within the gilt market. The UK was one of the first developed economies to issue index-linked bonds in 1981. Initially only tax-exempt pension funds were allowed to hold these bonds. The UK has issued around 20 index-linked bonds since then. Like conventional gilts, index-linked gilts pay coupons which are initially set in line with market interest rates. (Recently, real market interest yields for many (at times, all) index-linked gilts have been negative; but the coupons for new issues have been constrained to be at least +0.125%.) However, their semi-annual coupons and principal payment are adjusted in line with movements in the General Index of Retail Prices (RPI).

Ultra-long index-linked bonds, maturing in 2062 and 2068, were issued in October 2011 and September 2013 respectively, and a 2065 maturity is due to be issued in February 2016.

Indexation lag

As with all index-linked bonds, there are time lags between the collection of prices data, the publication of the inflation index and the indexation of the bond. From their introduction in 1981, index-linked gilts had an eight-month indexation lag (between the month of collection of prices data and the month of indexation of the bond). This was so that the amount of the next coupon was known at the start of each six-month interest accrual period. However, in 2005 the UK Debt Management Office announced that all new issues of index-linked gilts would use a three-month indexation lag, first used in the Canadian Real Return Bond market, and the majority of index-linked gilts now in issue are structured on that basis.

Double-dated gilts

In the past, the UK government issued many double-dated gilts, which had a range of maturity dates at the option of the government. The last remaining such stock was redeemed in December 2013, despite the continued reference to double-dated gilts in the price lists on the DMO website.

Undated gilts

Historical undated gilts

Until late 2014 there existed eight undated gilts, which made up a very small proportion of the UK government's debt. They had no fixed maturity date. These gilts were very old: some, such as Consols, dated from the 18th century. The largest, War Loan, was issued in the early 20th century. The redemption of these bonds was at the discretion of the UK government, but because of their age, they all had low coupons, and so for a long time there was little incentive for the government to redeem them. Because the outstanding amounts were relatively very small, there was a very limited market in most of these gilts. In late 2014 and early 2015 the government gave notice that four of these gilts, including War Loan, would be redeemed in early 2015. The last four remaining gilts, with coupons of 2.5% or 2.75%, were redeemed on 5 July 2015.

Proposed new undated gilts

In May 2012 the UK Debt Management Office issued a consultation document which raised the possibility of issuing new undated gilts, but there was little support for this proposal.

Gilt strips

Many gilts can be "stripped" into their individual cash flows, namely Interest (the periodic coupon payments) and Principal (the ultimate repayment of the investment) which can be traded separately as zero-coupon gilts, or gilt strips. For example, a ten-year gilt can be stripped to make 21 separate securities: 20 strips based on the coupons, which are entitled to just one of the half-yearly interest payments; and one strip entitled to the redemption payment at the end of the ten years. The title "Separately Traded and Registered Interest and Principal Securities" was created as a 'reverse acronym' for "strips".

The UK gilt strip market started in December 1997.

Gilts can be reconstituted from all of the individual strips. By the end of 2001, there were 11 strippable gilts in issue in the UK totalling £1,800 million.

Maturity of gilts

The maturity of gilts is defined by the UK Debt Management Office (DMO) is as follows: short 0–7 years, medium 7–15 years and long 15 years +.

Gilts with a term to maturity of less than three years are also referred to as "ultra short", while the new gilts issued since 2005 with a term to maturity of 50 years or more have been referred to as "ultra long".

GEMMA reference prices

The UK Debt Management Office publishes the Gilt-Edged Market Makers Association (GEMMA) reference price, a price collated by the DMO from mid-market closing prices submitted by each Gilt-Edged Market Maker for those gilts in which it makes markets (conventional gilts, index-linked gilts, or both, with the exception of rump gilts and STRIPS). As at February 2016, a review is to be undertaken as to the future provision of these reference prices.

See also

• List of government bonds

References