Bond trading, innovation and
evolution: a Bank of England
Perspective - speech by
Dave Ramsden
Given at Glaziers Hall, AFME Bond Trading, Innovation and Evolution
Forum
Published on 27 February 2024
Dave Ramsden discusses the Bank of England's evolving role in bond markets,
focusing on the Bank's approach to normalising its balance sheet and how it is
actively working with the market on the future of settlement infrastructure,
including through enhancing the RTGS service.
Speech
Introduction
Thank you to AFME for the invitation to speak at this first forum on bond trading, innovation, and
evolution. Given my responsibilities at the Bank my remarks will focus on our perspective of the
main themes of the forum in terms of our involvement in and engagement with these key sterling
wholesale markets in the financial system. Today's conference is well timed to take stock of the
evolution of the Bank's trading relationship with a core part of these markets, the market for gilts,
through the MPC's quantitative tightening (QT) programme, a key element in the normalisation of
our balance sheet.
The amount of gilts held in the Bank's Asset Purchase Facility (APF) on behalf of the MPC
reached a peak of £875bn in early 2022 and has since fallen back to £735bn.[1] As a share of
outstanding government debt, the share has fallen from 35% to 31%.
Chart 1: Holdings of gilts by sector(a)(b)(c)
Sources: UK Economic Accounts time series, UK Economic Accounts reference tables Quarter 3
(July to September) 2023 and Bank of England statistical reporting. Footnotes: (a) Outstanding
values represent contemporaneous market values, not face value of gilts at issue; (b) Monetary
and Financial Institutions includes Bank of England Holdings until 1998 Q2 when the series are
split; (c) UK households and private sector non-financial corporations are not visualised as their
collective holdings cannot be discerned in this chart.
At the same time, understanding and supporting continuing innovation in the settlement
infrastructure on which all financial markets rely, both as an enabler and an encourager, is a key
element in delivering monetary and financial stability. And this now too is a good time to update on
how the Bank's approach is evolving.
A brief history of the Bank's involvement in bond markets
To frame where we stand today, I'd like to start with some history. The Bank can track its
connection to bond markets all the way back to its incorporation in 1694. The Bank came into
being with the specific purpose of raising funds for England's war effort against France. To help
raise funds, the government created a new joint-stock company, where investors were effectively
purchasing government debt to become shareholders in the company. That company was the
Bank of England and so began the 330 years, and counting, relationship between the Bank and
bond markets.
The Bank's role in, and interaction with, markets has evolved over time. In July 1914, financial
markets were shaken by the sudden outbreak of World War One, with a run taking place in both
the London money market and the London stock exchange. The Bank stepped in, acting as a
'market maker of last resort' and buying substantial quantities of bills of exchange which resolved
the immediate liquidity crisis.[2]
More generally for much of its history the Bank, as the Government's banker, leveraged its market
connections to act as the key agent and adviser to the Government on debt management.[3] At the
same time as being given operational independence for monetary policy in 1997 responsibility for
debt management passed to the newly created Debt Management Office (DMO), though the Bank
continued to be the Government's banker. As the earlier chart showed for the twelve years from
1997 to 2009 the Bank's direct involvement with the gilt market, while it continued to be important,
was nevertheless limited to the kind of operations described by the Bank official quoted by David
Kynaston in his one-volume history of the Bank, "although we have less of a role in gilts, we have
quite a portfolio of gilts for our own customers, and we continue operating (for the Exchange
Equalisation Account) in the foreign exchange market."[4]
The Bank as a significant holder of government debt
The Global Financial Crisis (GFC) of 2007-9 marked a watershed moment across all financial
markets. Amongst other things, its aftermath led to the adoption of Quantitative Easing (QE) in
some jurisdictions, which transformed the role of central banks in the bond market, from engaged
observers and occasional traders to the largest participants. Across different jurisdictions, bond
purchases aimed to lower long-term interest rates, boost economic activity, and meet the inflation
target in the medium term. The 15th anniversary of the MPC's decision to start QE in March 2009
is next week.
Since the GFC, the global economy including the UK has been subject to a sequence of very large
and overlapping shocks. Four years ago, we were on the cusp of Covid lockdowns. Two years
ago, the Russian invasion of Ukraine began. And around 18 months ago, the Bank of England
intervened to protect financial stability, when forced selling by liability-driven investment (LDI) funds
led to fire-sale dynamics at the long end of the gilt market.[5]
In response to these shocks, the Bank and MPC have been able to use the balance sheet to
protect the economy in support of our mandate for monetary and financial stability. But as the
impacts from these shocks dissipate, our balance sheet is changing in response.
The future 'new normal' balance sheet
Turning to the present day the global and UK economies are moving on from the impacts of those
profound external shocks. While many of the economic developments ahead will hopefully look
and feel more familiar, in terms of low and stable inflation and growth in activity, the new normal for
the Bank's balance sheet is likely to seem less familiar in terms of its size and composition.
Central banks globally are considering issues relating to their future balance sheet. The Bank's
balance sheet peaked at over £1 trillion in 2022, as shown in chart 2. As Andrew Bailey noted in a
speech last April, irrespective of QE, a larger central bank balance sheet would be needed to
meet the financial system's demand for reserves and liquidity buffers, and the Bank will, therefore,
not shrink its balance sheet to the level it was
pre-GFC. At the moment we do not know precisely where the new normal level of reserves will be,
or what the composition of the assets backing those reserves will be.[6]
In the context of today's forum my focus is going to be on two particular features of the
normalisation process; first, the MPC's process of quantitative tightening (QT); and second, the
unwinding of our Term Funding Scheme with SME incentives (TFSME).
Chart 2: Bank of England reserves supply and backing assets
Source: Bank of England. Coloured areas summarise the Bank's main on-balance sheet sterling
facilities. The gap between the sum of those facilities and reserves primarily reflects sterling
banknotes. 'Term Funding' includes the Term Funding Scheme (TFS) and the Term Funding
Scheme with additional incentives for SMEs but excludes the Special Liquidity Scheme and the
Funding for Lending Scheme (which were funded off-balance sheet). To avoid double counting,
'loan to APF backing QE' excludes lending backing the TFS while it was in the APF (pre-2019);
prior to 2013 Q3, the series shows the quantity of assets financed by the creation of central bank
reserves on a settled basis. 'Other sterling facilities' includes Short-Term Open Market
Operations, Long-Term Repos, the Contingent Term Repo Facility, and the Covid Corporate
Financing Facility; it excludes the Sterling Bond Portfolio used to fund the Bank.
Quantitative Tightening
QT marks an important shift in our participation in bond markets, as we reduce our balance sheet
and return assets, including almost all our portfolio of corporate bonds and an increasing
percentage of our portfolio of gilts, to the private sector. The MPC has judged that reducing the
size of the APF has the important benefit of reducing the risk of a ratchet upwards in the size of
the central bank balance sheet over time, if successive policy cycles encounter the effective lower
bound on interest rates. In other words, it's important to normalise our balance sheet when we can
to ensure we have sufficient headroom to respond to future shocks.
The MPC has also been clear that QT should operate in the background, with Bank Rate as the
active monetary policy tool, and that sales should be gradual, predictable and not disrupt financial
markets.
In line with these principles, to assess market developments Bank staff look at a wide range of
quantitative indicators, including some based on transaction-level data. The Bank combines this
with market intelligence gathered from a broad set of market participants on both the buy and sell
sides, to monitor gilt market functioning and liquidity for any sign of disruption. We also stay in
close contact with the DMO. Based on our analysis to date, we have not found evidence that our
operations are disrupting financial markets, but we remain vigilant.[7] Consistent with its
commitment to transparency, the Bank publishes quarterly market notices setting out the schedule
of APF auctions for the upcoming quarter. The Bank also, on a quarterly basis, publishes a range
of scenarios for the unwind of the APF and, given the indemnity for the APF, the associated cash
transfers between HM Treasury and the APF.
Our QT auctions are going well, attracting strong demand, as reflected in good cover and pricing
for the Bank. As outlined in its December Market Notice, the Bank made a technical change to
its approach to setting auction sizes across maturity buckets from the start of 2024, to align our
approach with the terms in which the MPC thinks about the reduction of the APF. In practical
terms, this means that our auction sizes for shorter maturity bonds are now larger than for medium
and, in turn, long maturities. This purely operational change in our approach seems to have been
received well by the market, as reflected in feedback from market participants, and good
participation in the re-sized auctions.
Accountability is important and the MPC and the Bank engage actively with and contribute to the
debate about our monetary policy decisions and their implementation. In particular, we welcome
the Treasury Committee's recent report into QT and will consider its findings carefully.
TFSME
Another key element in the normalisation of the Bank's balance sheet is the start of the unwinding
of the TFSME. The scheme was launched in 2020 and was the latest iteration of a string of
lending schemes which offered cheap term funding to the banking system against a range of
collateral.[8] These schemes were launched in response to various shocks, starting from the
original Funding for Lending scheme in 2012 around the Eurozone crisis, followed by the TFS in
2016 following the Brexit referendum, and then the TFSME in response to Covid. They each
aimed to ensure the pass through of low interest rates and to sustain lending to the real economy,
and were each tailored to the specific circumstances faced at the time.
The TFSME is the largest of the schemes; drawings peaked at £193bn in 2021, and most
TFSME drawings will mature in 2025 under the contractual terms of the scheme, as shown in chart
3. We can already see that some firms are smoothing their repayment schedule and exit from the
scheme by repaying TFSME drawings in advance, and/or pre-funding its refinancing. And we
would encourage firms to continue to develop and maintain a stable repayment profile that takes
into account how the actions of other firms will affect the cost of this refinancing. We expect that as
part of these plans, banks will turn more to the wholesale funding markets than they have in recent
years, as private sector markets replace some of the term funding that the schemes provided.
Chart 3: Bank of England term funding schemes
Source: Bank of England
Managing the balance sheet
QT and the TFSME unwind mark an important shift in the size and composition of our future
balance sheet. But they should not be seen as the Bank stepping away from its appropriate role in
financial markets. We have a range of facilities in our Sterling Monetary Framework which allow
firms to borrow liquidity in the form of reserves as needed. We encourage usage of these facilities
as part of normal liquidity management, and while we would not expect firms to rely solely on our
facilities (and we have priced those facilities accordingly), they are also not intended to be used
as a last resort.[9] We are, and remain, 'open for business'.[10]
As our balance sheet reduces to whatever level is the new normal, reserves will fall towards the
minimum level of reserves that banks need and want, as shown in chart 4. This aggregate level of
reserves demanded by banks for transactional and precautionary liquidity needs forms what we
call the Preferred Minimum Range of Reserves (PMRR). At some point during the unwind, the
stock of reserves will eventually approach the minimum level needed by banks. At that point,
banks are likely to respond by seeking to borrow reserves in money markets, increasing the rates
they are willing to pay to do so, and thereby causing short-term interest rates to rise relative to
Bank Rate. If no other actions are taken, this would impair the transmission of monetary policy to
the wider economy. So, in 2022 we announced the launch of the Short Term Repo (STR) to supply
reserves on demand at Bank Rate against gilt collateral on a weekly basis, to ensure that market
interest rates remain aligned with Bank Rate. We expect usage of the full set of our liquidity
facilities to rise as the level of reserves in the system falls as QT and TFSME unwind progress.[11]
As already set out, the level of the PMRR and the timing for when it will be reached are both
uncertain, and indeed may change over time, as Andrew Bailey flagged in his Loughborough
lecture earlier in February.
Chart 4: Stylised supply of reserves during APF unwind
One key issue is the appropriate mix of assets that will back these reserves. We will decide this in
consultation with relevant stakeholders, including HMT. With that in mind, I want to draw an
important distinction between the MPC's reduction of the bonds held in the APF, and the future of
the Bank's balance sheet. Our approach to this issue differs from other central banks, notably the
Federal Reserve, which aims to maintain its QE portfolio at a level that will back an 'ample' level of
reserves.
The MPC decides on the stock of assets held by the Bank for monetary policy purposes. In line
with its policy objectives, it communicated its decision for the pace of QT over the following twelve
months, most recently in September 2023. The Bank's facilities for supplying reserves, including
STR, are designed to ensure that the MPC can remain focused on monetary policy when deciding
on the pace of QT. At the point that reserves reach the minimum desired level, banks will be able
to meet their demand for reserves at Bank Rate using the Bank's facilities, stabilising the quantity
of reserves and allowing the MPC to decide to continue reducing the stock of assets held in the
APF if it wanted to. The decision on the future size and composition of the balance sheet is a
separate issue, which we are thinking about carefully. To illustrate the separation, the MPC could
unwind the APF fully, if it judged necessary for policy reasons, and the level of the PMRR should
not affect this judgement.
The Bank's work to normalise its balance sheet marks another point in our history of evolving with
the needs of the economy and of financial markets. Depending on the context there may be step
changes in use of our facilities or usage may be steadier over time. But the Bank is committed to
providing sufficient reserves to meet its monetary policy and financial stability goals, and expects
its facilities, both existing ones and those required by the circumstances of the time, to be used at
scale to meet the demand for reserves.
The focus of my remarks has been on the normalisation of the Bank's balance sheet, in terms of
the APF, operating in the background in the context of the implications for monetary policy. But I'm
conscious that in terms of what has been driving market pricing much of the action, and the key
driver for recent movements, has been on what is expected to happen in the foreground, in terms
of expectations for Bank Rate.
Let me summarise my position as one of a majority of MPC members who judged that
maintaining Bank Rate at 5.25% was warranted at the time of our last announcement on
1 February. The sharp fallback in headline inflation to 4.0% in January, from 10.1% a year ago is
undoubtedly encouraging. The restrictive stance of monetary policy increasingly weighed on
activity through 2023, and, notwithstanding the ongoing uncertainties with the official data, has led
to a loosening in the labour market. I support the more balanced outlook on risks to inflation set
out in the MPC's latest forecasts. Although services inflation and wages growth have fallen by
somewhat more in recent months than we had expected last autumn, key indicators of inflation
persistence remain elevated. In terms of my thinking about the future, I am looking for more
evidence about how entrenched this persistence will be and therefore about how long the current
level of Bank Rate will need to be maintained.
Innovations in Payments and Settlement
Now, I'd like to shift my focus from normalisation of our balance sheet to innovation. I started my
remarks today by highlighting how understanding and supporting innovation in the settlement
infrastructure on which all financial markets rely is a key element in delivering monetary and
financial stability.
Our focus needs to be on understanding the risks and opportunities that innovation poses, and
what it means for how we meet our objectives. This is particularly important in these core markets,
where bond issuance and trading volumes continue to be significant. Indeed, I can draw on
AFME's own government bond data report to highlight that EU Member States and the UK
issued EUR 850 bn in bonds and bills in Q3 2023 alone, with average daily trading volumes
consistently hovering around EUR 100bn through the first three quarters of 2023.
Daily clearing and settlement in the City of London dates back to around 1770, when bank clerks
would meet at the Five Bells pub to exchange cheques in one place and settle balances arising in
cash. The first Banker's Clearing House was built in Lombard Street in 1833, and settlement in
cash was replaced by settlement across accounts held at the Bank of England in 1854. The
current institutional arrangement for securities settlement came into being in 1996, with the launch
of the CREST settlement system. This is underpinned by the Real-Time Gross Settlement service
(RTGS), which is also the means through which we operationalise the Bank's balance sheet.
Reserves are held in reserve accounts under the Sterling Monetary Framework within RTGS.
In our recent history the provision of the essential services supporting settlement of UK securities
has been in CREST, where the Bank continues to play a central role. In 2023 we settled on
average £342bn per day in CREST transactions. This is facilitated by the Delivery versus
Payment (DvP) link with RTGS first established in 2001, enabling transactions to settle in a series
of cycles throughout the day. This model eliminates settlement risk as transactions are settled in
central bank money, the ultimate risk-free asset, against segregated liquidity, with finality in real
time.
So, the state of the world is currently steady, but just because something has been steady and
constant doesn't mean we're not looking for ways to evolve. Indeed, I'd like to describe two
different ways in which we're evolving in the payments and settlement space: first, we're working
with the market, as an observer, encourager and enabler of innovation; and second, we're making
specific enhancements to RTGS, to provide a platform for innovation.
Monitoring, encouraging, and enabling innovation
There is a wide range of new innovative trends and initiatives that have the potential to materially
enhance the functioning of wholesale markets. This includes both specifically targeted work such
as the Accelerated Settlement Taskforce (which is exploring the case for shorter, T+1, settlement
cycles), as well as broader adoption of new technologies such as Distributed Ledger Technology
(DLT), programmability and tokenisation, to name a few. There are myriad potential applications
of these technologies but in broad terms benefits could include improved market liquidity, faster
settlement, reduced settlement risk, scope for greater automation and integration of payments into
other processes.
A wide range of new solutions using these new technologies are emerging in the market at
various stages of development from proof-of-concept to market deployment. In wholesale financial
transactions, applications of these technologies could enable consolidation of trading, settlement
and custody of assets, which could increase efficiency and reduce intermediaries, while making
trading and settlement (near) instantaneous.
These technologies present a number of potential benefits and widespread adoption could have
implications for the financial system. A particular focus of the Bank in 2024 is to think holistically
about the potential impact of these changes for monetary and financial stability and how they
might affect the Bank's provision of retail and wholesale central bank money, commercial banks'
provision of deposits, and non-banks' issuance of stablecoins for payments.
Taking a step beyond our monitoring efforts, we are also actively finding ways of encouraging and
enabling innovation. One such example is our work on the Digital Securities Sandbox.
The sandbox will enable the private sector to set up real-world trading venues and settlement
systems using new technologies such as DLT - to explore ideas like collapsing trading and
settlement into an instantaneous smart contract. The sandbox will amend regulations to remove
the barriers to using these new technologies, with limits on activity to allow markets and regulators
to gain practical insights into their potential benefits, while enabling that innovation to take place
safely. The Bank and the FCA will shortly consult on the rules and procedures for the sandbox, and
it will open for applications later this year.
Enhancements to RTGS
The most significant piece of work we're currently undertaking in this space is our work to
enhance the RTGS service. As recently highlighted by my colleague Victoria Cleland, the
Bank is making enhancements to RTGS to catalyse industry innovation in several key areas.
Some of these benefits may apply principally to payments, settlement, or both as illustrated by
three examples:
In 2021 we introduced a new 'omnibus account' model in RTGS, which allows an operator of a
payment system (PSO) to pool participant funds in RTGS to back transactions in their own
system. This allows the PSO to offer innovative payment services (including those using DLT)
while benefitting from the security of central bank money settlement. Fnality has become the
first omnibus account holder , offering a new type of Financial Market Infrastructure
underpinned by DLT.
In June 2023 we successfully migrated CHAPS payments to ISO 20022. As an established
international financial messaging standard, ISO 20022 has the potential to bring significant
benefits to the UK payments industry including greater resilience, interoperability, an improved
user experience and enabling innovation through provision of enhanced data. The greatest
benefits of ISO 20022 will, however, only be realised if industry embraces it and uses the richer
and higher-quality data that it offers.
Our next step is the transition to a new core settlement engine for RTGS, which will offer
enhanced capacity, the ability to accept CHAPS payments up to 10 days in advance and
enhanced liquidity-saving mechanisms. It will also be able to accommodate a substantially
higher number of account holders, offer streamlined and simplified onboarding and support
greater functionality through a new user interface for RTGS and Application Programming
Interfaces (APIs).
Facilitating innovation and competition is a key priority for the RTGS Future Roadmap beyond
2024. To this end we are undertaking work to develop features to enable use of new technologies
and business models. A key example in the context of the bond market is synchronisation,
whereby external ledgers - including those for securities - could connect to RTGS to synchronise
transactions. This would enable 'atomic settlement', whereby the transfer of two assets is linked in
a way that one asset moves if and only if the other asset also moves. This could modernise for the
digital world the DvP concept that was pioneered with the RTGS-CREST link, and extend it to a
wide range of markets.
Underpinning all these enhancements is resilience, which is absolutely central to our provision of
the RTGS service and will remain so. The new core RTGS settlement engine will already have
even more enhanced resilience built in to ensure prompt and secure settlement in a world of new
and emerging threats. As part of the future roadmap for RTGS, we are exploring how to enhance
resilience further by introducing an additional channel to send and receive payments to RTGS,
offering participants greater choice in how they connect to our settlement service. Additional
channels to RTGS would also help to reduce market reliance on any single third party for
payments messaging.
Overall, we believe that the package of enhancements that we are developing can provide the
conditions for innovative new business models to emerge. But this vision can only become a
reality if industry players join us on this journey, both through co-creation and effective co-
ordination.
Co-creation with stakeholders will ensure that we benefit from industry steers on the development
of the individual features, as well as the strategic shaping of the RTGS Future Roadmap. Industry
input is essential as we continue to shape the future of RTGS to best meet the needs of the UK
economy. Drawing on our ongoing co-creation work, I would like to highlight our recently published
discussion papers on access to RTGS accounts for settlement and exploring longer
operating hours for RTGS. While we have not made any decision on whether to move to longer
operating hours, an extension could serve as a catalyst for further innovation, help to reduce
settlement and credit risk and enhance domestic and cross-border payments. I would encourage
everyone with an interest to respond to both papers.
Finally, our achievements to date have only been possible thanks to industry co-ordination to
adopt standards and to invest in necessary technological improvements. As we look ahead to
opportunities to enhance and improve settlement practices in the bond market, a similar level of
co-ordination and collaboration between industry and the Bank will be essential.
Conclusion
The purpose of today's forum is to discuss innovation and evolution in bond markets. I've hopefully
given you a sense of how the Bank is developing its approach, much in the same way that it has
been evolving to the needs of the markets it operates in for the last 330 years. On the one hand
we're normalising our balance sheet, transitioning to a new normal that in terms of our
participation will frame the environment for further innovation. And on the other, we're actively
working with the market to utilise the significant technological developments we're seeing within
the settlement infrastructure we operate.
We are mindful that the shocks in recent years have shown that we cannot take stability for
granted, and so one core principle underpinning all our work to innovate and evolve, as well as in
terms of our direct participation in markets, is the objective to maintain monetary and financial
stability for the good of the people of the United Kingdom.
I would like to thank Johnny Elliot, Richard Lewis, Ed Kent and Rachita Syal for their help in
drafting this speech, as well as many other Bank colleagues for their helpful comments and
suggestions.
1. These data on balance sheet holdings are reported on an initial purchase proceeds basis, whereas the data displayed
in chart 1 shows gilt holdings in market value terms.
2. Bank Underground (2019), 'The Great War and the Bank of England as Market Maker of Last Resort'
3. Goodhart (2018), 'The Bank of England, 1694-2017'
4. Kynaston (2017), 'Till Time's Last Sand: A History of the Bank of England 1694-2012'
5. For further detail, see the Bank of England's Quarterly Bulletin Article 'Financial stability buy/sell tools: a gilt market
case study'
6. For further detail, see Andrew Hauser's speech ''Less is more' or 'Less is a bore'? Re-calibrating the role of central
bank reserves'
7. For further detail, see Dave Ramsden's speech, 'Quantitative tightening: the story so far'
8. The TFSME is a lending operation backed by collateral and is not indemnified by HMT. It is held on the Bank's balance
sheet rather than in the APF.
Page 14
9. The Bank is also developing the liquidity tools it has for supporting financial stability. This includes building a new
backstop facility capable of lending to non-bank financial institutions (NBFIs) against high quality assets, which will be
used to address dysfunction in core UK financial markets that is severe enough to threaten financial stability. The
development of this lending facility will reduce the need for the Bank to support financial stability in future by undertaking
financial stability asset purchases, as it did during the 2022 LDI episode.
10. For more information on trends in bank funding and liquidity, see Box D of the December 2023 Financial Stability
Report.
11. For more detail, see 'Explanatory Note: Managing the operational implications of APF unwind for asset sales,
control of short-term market interest rates and the Bank of England's balance sheet'
Dave Ramsden
Deputy Governor, Markets and Banking
©2024 Bank of England