What are gilts?

In most developed markets, government treasuries (govies) — debts issued in the name of the government — are popular amongst investors due to their stability, high liquidity, and tax advantage. They are somewhat another form of money despite that they bear interests. (Perhaps not the case for Argentinian government treasuries)

If you are an American, you might have heard of T-bill, T-note, T-bond, etc. In the UK, the equivalence is called Gilt-edged securities, or simply Gilts. They are called gilts because back then the public debts were on paper gilded with gold. The idea is the same, the government periodically issues some debts, investors buy them, and investors get paid upon maturity. Don’t worry about the default as British money printers work as efficiently as American ones.

Who issues Gilts?

In the US, treasuries are issued by the Department of Treasury, though some people think it’s issued by the central bank Federal Reserve. How about the UK?

Gilts were first issued in 1694 by the Bank of England — the central bank — to fund the Nine Years’ War. After 1998, gilts are issued by the Debt Management Office (DMO)* , an agency under HM Treasury* . It’s also worth noting that since 1998, insurance has increased 5 folds.

n.b. In most developed markets, public debts are issued under the Treasury instead of the Central Bank for better government cashflow management. Here’s an article explaining their roles and why they should be independent.

n.b. HM (His/Her Majesty’s) is a common prefix for UK government agencies. e.g. HMS → His Majesty’s Ship

Conventional Gilts

Most of the gilts are conventional, i.e. bullet bonds.

Like U.S. Treasuries, gilts pay interest semi-annually and are auctioned in the primary market. And like in the U.S., there is a group of primary dealers required to participate in the UK debt auctions. Those dealers are called Gilt-edged market makers (GEMMs).

They are issued with 1 of 3 sets of aligned coupon dates:

• Mar 7th & Sep 7th
• Jun 7th & Dec 7th
• Jan 22nd & Jul 22nd

Index-linked Gilts

In the U.S. there’s TIPS (Treasury Inflation-Protected Securities), which is linked to CPI (Consumer Purchasing Index). As the name indicates, such security is to protect investors from inflation, so coupons and prices are adjusted or uplifted based on the inflation.

In the U.K., the equivalence is the index-linked gilt (ILG). It is linked to the RPI (Retail Price Index). In 2030, index-linked gilts will be linked to the Consumer Price Index including housing (CPIH).

n.b. When using the index to calculate cash flow, there is a 3-month lag. Read more about how to calculate ILG cash flow

RPI vs. CPI

RPI is also a measure of inflation, but RPI also includes the factors in housing, (e.g. inflation in rents).

Gilts market operations

Primary Market

Gilts are issued by auction, syndicated offering, or mini-tender offering.

• Conventional Gilts use multi-price auctions. DMO will keep accepting the highest bid until all issurance is fully allocated. Bidders get security at the price they bid. To encourage higher bids, the prices bid by others are unknown to each other.
• Index-linked gilts use uniform-price auctions. Bids are ranked, and the lowest accepted bid will be the “clearing” bid so that every accepted bidder gets the same price. This mechanism prevents the “winner’s curse”

Secondary Market

After gilts are auctioned, they are listed and traded on the London Stock Exchange.

n.b. DMO also trades in the secondary market, but they only deal with Gilt-edged market makers (GEMMs).

n.b. GEMMs have access to the services of acknowledged inter-dealer brokers (IDB), who serve as intermediaries between GEMMs

Pricing convention

Gilts market prices are quoted and traded on a “clean” price. For conventional gilts, prices are negotiated and traded per £100 face amount

Settlement

Gilts are settled by CREST (Certificateless Registry for Electronic Share Transfer), the UK's central securities depository. Generally, settlements are T+1.

n.b. Gilts can be strippable. Through CREST, GEMMs can strip and reconstruct gilts.

What to do with Gilts?

Due to their stability, pension funds love to hoard them.

For UK residents, capital gain from gilts is tax-exempt if they are held in individual saving accounts (ISA).

Gilts can also be used as a monetary policy tool. Since 2009, the Bank of England has hoarded hundreds of billions of gilts in their quant easing (QE) portfolio. I will write another article about the impact of QE in the UK.