How B.C. debt is managed
The Province of British Columbia issues debt to finance operations and capital projects. The provincial government also provides financing to Crown corporations and other public sector organizations.
The primary objective of debt management is to manage the cost of debt and associated risk in a manner that is consistent with the long-term financial objectives of the Province. This entails managing the debt portfolio to minimize the total cost of existing and new debt, subject to an acceptable level of risk.
Debt Management Branch
The Debt Management Branch is part of B.C.'s Provincial Treasury, and provides centralized liability management services to the government and its Crown corporations and agencies. Its mandate is to manage the debt liabilities of the Province to be at the lowest long-run cost without taking on undue risk.
In addition to borrowing funds to meet client requirements, the Debt Management Branch manages all principal and interest payments over the life of a debt issue and enters into derivative product transactions to manage interest rate and foreign currency exposure.
The Ministry of Finance Risk Committee is a senior management committee that is comprised of:
- The Deputy Minister of Finance, whom acts as the Chair
- Four (4) seats which are assigned to non-government affiliated finance professionals
Other active participants in the Committee include:
- Assistant Deputy Minister of Provincial Treasury
- Assistant Deputy Minister of Treasury Board Staff
- Members of the Debt Management Branch
The role of the Committee is to act as a senior advisor with respect to the Province's liability management, policies and activities. It provides direction on risk appetite, policy, borrowing strategy and risk exposure, and functions as a monitor and compliance review board. However, only the Chair of the Committee has the authority to approve risk parameters, debt management borrowing strategy, foreign currency exposures and unique capital market issuance.
The Committee meets with senior staff from Debt Management Branch and Treasury Board Staff on a quarterly basis, or as necessary. The purpose is to make recommendations and/or provide financial advice to the Deputy Minister of Finance regarding the financial risks of the Debt Management Branch as they relate to the management of its liability portfolios, and including, but not limited to:
- The annual borrowing strategy
- Risk management parameters of the debt portfolio
- Collateral management frameworks
- Advice on investment policies of the government's CRF funds/trust funds
- Other projects or ad hoc initiatives, as and when required
Parameters and policies
The following parameters were established to minimize risk associated with the management of the debt of the Province.
Provincial Treasury will typically manage its funding program ahead of actual requirements, thus mitigating the risk of accessing the market when interest rates are high or market conditions are not receptive to new financing.
While Provincial Treasury may rely on its outlook for interest rates and foreign exchange to guide the timing of its decisions for financing, fixed-rate debt costs are generally averaged-in over the course of a year. Financing a large annual borrowing requirement strictly in accordance with a market outlook that may prove to be incorrect is considered to be imprudent.
In addition, Provincial Treasury has instituted measures to help safeguard against the possibility of severe financial market volatility that could impair the government's financing ability. These measures include:
- Managing the size of outstanding short-term debt through use of long-term floating rate debt, which increases the government's capacity for short-term financing if long-term debt markets become unfavourable.
- Using the warehouse borrowing program from time to time to take advantage of attractive borrowing opportunities in advance of actual requirements.
- Funding a matched book program. Under this program, the Province borrows funds and then reinvests them at comparable interest rates using high-grade, low-risk instruments. Since the incurred debt liabilities are offset by the investment assets, the implied increase in net debt is zero. If a market disruption were to occur, the currency denominated assets held by the matched book program can be liquidated if necessary.
Restrictions on the Province's maturity profile allow for the orderly retirement of future debt obligations without incurring undue refinancing risk, thus minimizing borrowing cost volatility. The government deliberately issues its debt securities across the full range of terms from one to 40 years. A broad mix of debt maturities avoids crowding of refinancing in any year and further reduces the government's exposure to future interest rate risk. As a result of this policy, the Province's refinancing schedule is well-balanced, with averaged annual net maturities over the next 20 years.
In order to manage the retirement of its debt, the provincial government uses sinking funds. Other than a few exemptions for some larger Crown corporations, all Crowns are required to establish a sinking fund and make annual sinking fund payments for any long-term loan greater than $20 million and with a term of five or more years.
Borrowing sources are diversified to cultivate strong domestic and international investor demand for British Columbia debt securities. Strong demand helps minimize financing costs for the province. A broad investor base is also important when competition for funding is increased and there is a need for multiple funding sources during times of difficult and volatile global capital markets.
British Columbia borrows from a variety of sources, including public financial markets in Canada, the United States, Europe and Asia, as well as the Canada Pension Plan Investment Fund and private institutional lenders.
From time to time, the government issues debt denominated in foreign currencies. The cost of repaying and servicing foreign currency denominated debt varies with the changes in the value of the Canadian dollar relative to debt denominated currencies. The exposure of the government's debt portfolio to changes in the value of the Canadian dollar can be effectively offset through various financial instruments, including currency and interest rate swaps.
The Ministry of Finance Risk Committee has set the maximum allowable foreign currency exposure for the B.C. government's direct debt and the debt incurred for education, health facilities and public transit up to 10% of debt outstanding.
Among the Crown corporations, only British Columbia Hydro and Power Authority (BC Hydro) carries U.S. dollar debt exposure. BC Hydro's U.S. dollar debt obligations are largely hedged through BC Hydro's U.S. dollar revenue inflows, as well as through other financial hedges.
Subject to parameters recommended by the Ministry of Finance Risk Committee, the Debt Management Branch may use derivative financial products to hedge interest rate and currency risks associated with the existing debt portfolio and new borrowings. These financial products are not used in a speculative manner. The use of these financial products provides the Province with a sufficient degree of flexibility for raising funds, while ensuring that the cost of debt servicing and repayment is maintained within an acceptable range. Use of these products enables the Province to:
- Access funding from foreign currency debt issues when there is an opportunity for substantial savings compared with Canadian dollar financings in the domestic market
- Access the market for funds when the market is most receptive while maintaining the Province's strategy to average-in the timing and cost of its fixed-rate funding
Since the Province may be subjected to risk of default by the counterparty under the terms of a financial product transaction, the Risk Committee has set restrictive and high credit criteria for qualifying acceptable counterparties. Counterparty credit agreements negotiated with financial institutions have been designed to provide legal and business protection to mitigate risk in favour of the Province.
Learn more about government spending and borrowing.
Definition of debt vs. deficit
Debt represents the money borrowed from lenders for a variety of reasons, and using a variety of debt instruments including short-term notes, capital leases and bonds. The Province pays interest for the use of the money it borrows and is obligated to repay it at a set date as determined by the terms of the debt instrument. For bonds, the Province contracts to pay the bondholder a stipulated rate of interest on specific dates over a stated period of time. At the end of this time the Province agrees to repay the principal amount against the surrender of the bond. For other debt instruments, the interest is a component of the payment that is due when the instrument matures.
Deficit is an excess of expense over revenue. The annual deficit is the amount by which the total annual operating expenses for the year exceed total annual revenues. The accumulated deficit is the sum of all deficits and surpluses incurred since the inception of the B.C. government. It also represents the amount by which the total liabilities of the Province exceed its total assets. Deficit spending is the spending of public funds raised by borrowing rather than by taxation.
General policy guidance on the priorities of government is set by the Executive Council or Cabinet. Translating these priorities into services that are delivered to the public is done by three general groups within the government reporting entity:
- B.C. government ministries
- Taxpayer-supported service delivery agencies
- School districts, public post-secondary institutions and health authorities
The proposed public spending by these organizations is set out in the government's budget and fiscal plan each February.
As part of the budget process, cabinet ministers submit annual estimates of their ministry's spending to the Legislative Assembly for inclusion in the annual appropriation bill known as the Supply Act. Ministries are responsible for both provision of services directly to the public and funding to other organizations such as the taxpayer-supported service delivery agencies, and the public education and health sectors in support of their activities. Each ministry's financial appropriation is subject to debate and vote by the Assembly.
The expectations of government with respect to the services to be delivered by taxpayer-supported service delivery agencies are set out in letters of expectation between the boards of the individual agencies and their respective responsible ministers. The boards then direct the management of the agencies in the delivery of the expected services.
The public education and health sector entities primarily are governed by legislation. As well, the individual ministers responsible for the programs that the public education and health sector entities deliver provide instruction to the boards on specific policy issues. The boards, in turn, provide direction to their management teams on the delivery of service to the public. The government's financial year runs from April 1 to March 31 of each year.
Expected costs and risks of a debt portfolio will vary depending on its debt composition. Interest and exchange rate exposure will have a direct impact on the risks and costs associated with a given portfolio. In general, as the expected cost of a portfolio is reduced, the variability of the cost and risk increases.
In order to monitor risk and measure performance, debt managers require a target or benchmark as a reference point. The Debt Management Branch selects a benchmark by quantifying the cost and risk of many portfolios, and chooses one that minimizes cost subject to an acceptable level of risk.
The Province must adhere to certain policies and parameters with respect to management of the public debt portfolio. One of these policies is to "avoid funding under unfavourable market conditions." Accordingly, the Province will typically manage its funding program ahead of actual requirements.
Another reason the Province might borrow funds when the budget shows a surplus relates to the accounting treatment of capital projects according to Generally Accepted Accounting Policy. Costs relating to capital investments, such as hospitals, schools and roads, are amortized for depreciation over the expected life of the asset. For example, a $300 million road project that may cost $10 million in annual amortization (from an accounting perspective) but would still need to be funded upfront during the construction period. Consequently, the Province may need to borrow in order to fund the full cost of the capital asset, irrespective of the fact that it has an operating surplus.
The Province also borrows on behalf of Crown corporations which is part of the provincial borrowing program. Accordingly, the Province would still borrow funds for Crowns with an operating deficit or for capital purposes, even though the Province itself might have a balanced budget or surplus.