Gilt-edged securities

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Gilt-edged securities are bonds issued by certain national governments. The term is of British origin, and originally referred to the debt securities issued by the Bank of England, which 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.

The data collected by the British Office for National Statistics reveal 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.

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[edit]

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[edit]

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[edit]

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. (Historically some gilts, intended primarily for higher rate taxpayers, were issued with coupons below the market rate. A few undated gilts pay quarterly interest.)

Gilt names[edit]

Historically, gilt names referred to their purpose of issuance, or signified how a stock had been created, such as 10¼% Conversion Stock 1999. 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[edit]

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
  • an increase in the volume of issuance as the Public Sector Borrowing Requirement has increased
  • a large volume of gilts have been repurchased by central government under its quantitative easing programme

Index-linked gilts[edit]

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 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).

In September 2005, the UK Government issued the longest ever index-linked government bond, 1¼% Index-linked Treasury Gilt 2055, maturing on 22 November 2055. Further ultra-long index-linked bonds, maturing in 2062 and 2068, were issued in October 2011 and September 2013 respectively.

Indexation lag[edit]

As with all index-linked bonds, there is a time lag 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[edit]

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 the 12% Exchequer Stock 2013-2017, a "rump gilt" with a relatively small amount outstanding and a very limited market, and this was redeemed on 12 December 2013.

Undated gilts[edit]

There exist eight undated gilts, which make up a very small proportion of the UK government's debt. They have no fixed maturity date. These gilts are very old: some, such as Consols, date from the 18th century. The largest, War Loan, was issued in the early 20th century. The redemption of these bonds is at the discretion of the UK government, but because of their age, they all have low coupons, and for a long time there has therefore been little incentive for the government to redeem them. However in early 2009, and again in late 2011, and at various times since then, the yield on these gilts, and in some cases also the coupon, has been higher than the redemption yield on long-dated redeemable gilts, which implies that the market is pricing in the chance that the government might redeem these gilts at some point. The question of the redemption of War Loan has now been publicly raised. Because the outstanding amounts are relatively very small, there is a very limited market in most of these gilts. In May 2012 the 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[edit]

Certain 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[edit]

The maturity of gilts is defined by the 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".

See also[edit]

References[edit]

  1. ^ OECD public debt markets: trend and recent structural changes. Organisation for Economic Co-operation and Development. 11 June 2002. ISBN 92-64-19761-3. 
  2. ^ PNB Gilts
  3. ^ "A Brief History Of British Gilt Edged Securities". Gilts360.com. January 1, 2013. 
  4. ^ Choudry, Moorad; Cross, Graham "Harry"; Harrison, Jim (June 19, 2003). Gilt-Edged Market (Securities Institute Operations Management). 
  5. ^ "UK Government index-linked gilts". ShareWorld. 25 March 2009. Retrieved 12 January 2012.