Mr. Seamus McCarthy:

The National Treasury Management Agency's primary function is to manage borrowing on behalf of the State. The results of that borrowing activity are reported in the agency's national debt account, which is also reproduced as part of the finance accounts. However, the account does not reflect the total indebtedness of the State. Consequently, one of the main objectives of chapter 2 is to provide a more complete picture of Government debt than that reported in the accounts of the NTMA.

General Government debt is the standard measure used to report Government debt under the Maastricht treaty. At the end of 2011, the general Government debt stood at approximately €169 billion - an increase of €25 billion, or 17%, year-on-year. The end-2011 debt represented 106% of gross domestic product, compared with 92% a year earlier.

The principal components of the general Government debt are borrowing by the NTMA on behalf of the State and promissory notes issued in 2010 by the Minister for Finance to the Irish Bank Resolution Corporation and the EBS. The balance outstanding on the promissory notes at end-2011 was just over €28 billion.

Borrowing by the NTMA is referred to as the national debt. The gross national debt stood at €137 billion at the end of 2011 and increased to just under €151 billion by the end of June 2012. The first tranche of funding under the EU-IMF programme of financial support for Ireland was provided in early 2011 and by mid-2012 borrowing from this source accounted for a third of the gross national debt.

Approximately 90% of the debt is now in the form of medium to long-term debt. Figure 2.4 in chapter 2 presents a maturity profile of that debt as at June 2012. This indicates that approximately €42 billion falls due for repayment between now and 2016. A further €58 billion falls due for repayment in the period 2018 to 2020. I should point out that repayments due on the promissory notes are not included in this analysis since they do not form part of the borrowing by the NTMA.

Between September 2010 and July 2012, the NTMA did not actively seek funding in the bond markets because the cost of borrowing would have been too high. Since mid-2011, there has been a sharp fall in the cost of borrowing. For example, yields on Irish ten-year bonds declined from a high of 14% in July 2011 to just over 6% by the end of June 2012. This has allowed the agency to re-enter the market. The Accounting Officer will be able to update the committee on the current position in that regard.

At the end of June 2012, the NTMA estimated that the weighted average cost of servicing the national debt stood at approximately 4.1% per annum. The average interest rate on Government bonds was estimated to be just under 4.8%, and the average rate on borrowing under the EU-IMF programme at 3.35%. In contrast, the average annual interest rate on the promissory notes is estimated at just under 6%.

As the committee is aware, the National Treasury Management Agency is a complex organisation with multiple functions that extend beyond its original and core role in managing Ireland's national debt. The additional functions include management of compensation claims on behalf of certain State authorities through the State Claims Agency. Awards and costs of settling claims amounted to €110 million in 2011. At the end of 2011, the estimated future costs for settling outstanding claims was estimated at almost €1 billion.

The NTMA also carried out certain banking functions on behalf of the Minister for Finance in the period March 2010 to early August 2011. In August 2011, the delegation to carry out those functions was revoked and the NTMA banking unit was seconded to the Department of Finance. Under a direction from the Minister, all costs of the unit, comprising staff and certain consultancy costs, continued to be met by the NTMA until the end of 2011. The unit's costs for the final five months of 2011 amounted to €6.3 million. The NTMA continues to bear the salary costs of the staff seconded to the Department while the unit's consultancy and other costs are borne by the Department since the start of this year.

Other functions and services of the NTMA, which are outlined in chapter 25 of my report, include: the management of the National Pensions Reserve Fund; provision of staff and services to the National Asset Management Agency; and the provision of financial advice in respect of PPP and other large capital projects through the National Development Finance Agency whose role now also includes the procurement on an agency basis of certain PPP projects.

The New Economy and Recovery Authority, called NewERA, was established within the NTMA in late 2011 on a non-statutory basis. The total costs of running the NTMA, as reported in its administration account, amounted to almost €95 million, of which the agency recouped €51 million. This comprised just under €28 million from the National Asset Management Agency and €23 million recovered from credit institutions receiving State support.

The third chapter under review by the committee concerns the National Pensions Reserve Fund. I will deal first with contributions to the pensions fund. The 2000 Act which established the fund required an annual Exchequer contribution of 1% of gross national product. For the period 2009 to 2011, this requirement was met through the provision in 2009 of €3 billion in Exchequer funding towards the cost of the fund's recapitalisation of Bank of Ireland and AIB and by the transfer to the fund in 2009 and 2010 of €2.1 billion in pension scheme assets from universities and some non-commercial semi-State bodies. Some €1 billion was repaid from the fund to the Exchequer in 2011 at the direction of the Minister for Finance. Under the Credit Institutions Stabilisation Act 2010, the Minister may direct that no contribution be paid into the pensions fund in 2012 and-or in 2013.

The value of the fund at the end of 2011 stood at €13.4 billion. The NPRF holds two types of investments. First, it holds a discretionary portfolio where investments are made in accordance with a strategy determined by the National Pensions Reserve Fund Commission. This portfolio delivered a return of 2.1% during 2011 and its value was just under €5.5 billion at the end of the year. Second, it holds a directed investment portfolio used to fund investments in Bank of Ireland and AIB at the direction of the Minister.

During 2011, €10 billion was transferred out of the discretionary portfolio to the directed investment portfolio. This was used to bring the fund's gross investment in the two banks to €21.6 billion, including the effective investment of €819 million in dividend returns received in the form of ordinary bank shares.

Following the disposal of shares to the value of €1 billion in Bank of Ireland in July 2011, the fund's net investment at cost amounted to €20.6 billion. By the end of 2011, the value of the holdings in the two banks stood at just under €8 billion - a drop of 61% relative to the net investment amount. When income, gains and proceeds of sales of warrants attached to preference shares are taken into account, the decline in value was 53% of the net investment.

In order to raise the €10 billion required to meet the 2011 investment in the two banks, the NPRF was required to liquidate the assets transferred out of its discretionary portfolio. When a large-scale liquidation of this nature occurs, the NTMA, following standard fund management practice, engages transition managers to dispose of the assets. The purpose is to enable market risks, operational risks and costs to be minimised and managed systematically.

Chapter 4 reports on charges applied by one of the firms appointed as transition managers. The firm was selected from a panel created by NTMA following a 2007 tender competition. The transition management firm - UK-based State Street Bank Europe Limited - was contracted to liquidate €4.7 billion of assets.

The disposals took place between February and May 2011 and the agreed fixed rate for the service was €698,000.

However, in addition, the firm applied commissions of €2.6 million for which there was no contractual provision and earned a further $790,000, equivalent to €600,000, in profits from the disposal of NPRF’s holding in an index fund. In doing this, it acted as a principal, rather than as an agent, but without taking the risk of loss. The additional charges were deducted from the disposal proceeds before these were remitted to the NPRF. The effect of the additional charges, while representing just 0.07% of the value of the assets sold, was to increase the amount earned by the transition manager to over five and a half times the contractual payment.

The unauthorised commissions came to light in late 2011 in response to inquiries made to the transition manager by the NPRF, arising from media reports about problems with transition services they had provided to other customers. The profits earned from the disposal of the holding in the index fund were notified by the transition manager to the NPRF in July 2012 following internal investigations the firm carried out. The transition manager has refunded the NPRF in respect of both of these amounts, a total of €3.2 million.

The performance of transition managers is generally measured by what is referred to as an implementation shortfall outcome. This compares the outcome against a pre-transition estimate within an acceptable level of deviation. The NPRF’s review of the transition executed by the transition manager found that the outcome was comfortably within the estimated range. Our examination concluded that while the implementation shortfall outcome provides a reasonable basis for benchmarking and evaluating the overall performance of a transition, its suitability for checking commission costs is questionable, given what occurred in this case. In addition, reliance by NPRF on the normal internal controls of regulated service providers may not be sufficient to prevent or detect non-contractual charges when assets are disposed of.

Chapter 4 contains a number of recommendations that aim to address this situation, in particular the commissioning of independent third-party reviews of the outcome of a sample of transactions.