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P O L I C Y B R I E F I N G 0 3 | 2 0 2 0

Creating liquidity in the government bond market in Belarus: what potential for ‘market makers’?

Alexander Lehmann

Berlin/Minsk, March 2020

B E L A R U S

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I. Liquidity in bond markets

II. The record of primary issuance in Belarus

III. Primary dealers and market makers

IV. Recommendations

References

Outline

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I. Liquidity in bond markets

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Liquidity is highly desirable:

• Reduces funding costs, as primary issuance becomes more efficient

• Facilitates secondary market transactions (liability management) by the debt management office (DMO)

• Yield curve for state debt can become a benchmark for pricing of private securities

• The government debt market is typically instrumental in developing the local currency bond market:

– The state is the highest quality domestic issuer; its yield curve is essential for pricing of all other instruments

– The local financial system requires a risk-free instrument for liquidity management

Bond market liquidity

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Average daily trading volumes and turnover ratios in CEE government bond markets

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Source: AFME government bond statistics, Q3 2019; Note: Turnover ratios are calculated as the average daily trading volume relative to total outstandings

Poland Hungary

Romania Bulgaria

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• Capital markets in Belarus show moderate depth, but no liquidity

• Bond market capitalisation in local currency is quite diverse: the outstanding amount of USD 6.0 bn or 9.5% of GDP has been issued by about 255 entities in 2019

• Less than 20% of domestic state debt is in BYN

Objectives

• The 2019 Financial Market Strategy calls for regular BYN issuance in the domestic market

• The 2020 State Programme for Public Finance Management anticipates a steady increase in the share of BYN issues in the domestic market over the next five years

• The entry of foreign investors is being prepared, and could raise liquidity

The sovereign bond market as a catalyst in capital market development

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Source: Ministry of Finance; data as of 1 January 2020

Source: IMF, own estimates; data as of 1 January 2019

0

15

30

45

60

BGR BLR SRB ROU RUS ARM UKR POL HUN

Government Corporate% of GDP

Outstanding local currency debt securities

Outstanding debt securities by type

Banks28%

Corporate29%

Central gov.29%

Local gov.10%

NBB4%

(Total= BYN 30 m)

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II. The record of primary issuance in Belarus

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• Domestically issued debt is primarily in FX. There were no BYN issues in 2018-19.

• Maturities of domestic FX bonds have lengthened, over 90% > 5 years (which is unusually long for a market at an early stage of development).

• Direct sale has been the preferred mechanism of sale.

• Since 2019, all issues were registered at the BCSE.

• Auctions are still rare (only 5 in 2019).

State debt issuance 2017-2019

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Evolution of government domestic bonds in foreign currency

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0

200

400

600

800

1000

1200

2015 2016 2017 2018 2019

<3 years 3-5 years

5-10 years >10 years

a. by maturity b. by issuance type*

0

200

400

600

800

1000

1200

2015 2016 2017 2018 2019

USD m AB DB DS

Source: Ministry of Finance, and GET calculations

Note: *AB = auction through the BCSE, DB = direct sale through BCSE, DS = direct sale to a legal entity

USD m

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• With reference to best practice in other emerging markets the transparency of issuance plans in Belarus could be improved:

– Only with the 2020 State Programme for Public Finance Management did some elements of a debt management strategy become public (e.g. how risks are assessed, and how the BYN component is to go up).

– Specific benchmark securities could be targeted.

• Issuance should be on market terms:

– Direct placements should be phased out

– Auctions should become the sole option for placement under the Ministry decree governing issuance. Only on this basis can a market price for funding be established, and subsequent trading can emerge

– The DMO should be predictable, and accept prices as offered by primary investors, unless an auction can be clearly seen to have failed (e.g. due to a very high dispersion of bids). Opportunistic behaviour (surprises) will in the long term lead to higher funding costs.

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Communication with investors could be improved

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III. Primary dealers and market makers

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In a primary dealer system issuance is based on an agreement between the issuing agency and a set of dealers to support the functioning and development of primary and secondary markets for government securities

• Objective criteria for entry and exit need to be defined (including capital requirements), also standards governing trading practices and disclosure

• Obligations are generally: – Participating in the primary market in a substantial and consistent

manner

– Act as ‘market maker’ in the secondary market (offer ‘two-way’ quotes)– Provide market related information to the ministry (debt manager)

• Privileges for the PDs vary more widely:

– Exclusivity in participating in auctions– Additional non-competitive allocations– Access to a security borrowing facility within the clearing house, or

directly from the DMO will enable the role of market maker

Role of primary dealers (PDs)

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➢ The PD system defines eligibility of key dealers and a balance between their obligations and privileges.

➢ In the absence of such a framework and benefits, individual requirements are likely to be ineffective or damaging to financial stability.

When should Belarus consider such a system?

➢ When there is a diverse investor base, e.g. once foreign investors have entered the market. As yet, the shallow investor base, and the concentrated and somewhat fragile state of the banking system suggest a PD system would be premature

➢ Currently, there is a risk of collusion among the few large banks participating in the market, which could be costly for the budget

When should a PD system be considered?

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• The obligation for PDs to provide two-way quotes continuously is a standard practice in the capital markets of advanced countries.

• Under the European market regulation (MiFID II) any regulated exchange must have in place sufficient number of firms acting as market makers.

• In emerging markets there are generally more limited commitments:

– A subset of outstanding securities;

– A specific time window;

– Require only an indicative quote;

– That primary dealers upon request offer a price within that indicative range.

– Exceptions in times of market disturbance

• Poland: Treasury Security Dealers are required to participate in the electronic market as market makers

• Ukraine: primary dealers required to serve as market makers by purchase or sale of at least 3% of turnover in each half year.

‘Market makers’

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IV. Recommendations

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➢ Predictability and transparency. The 2020 state programme for Public Finance Management could become more detailed on risks and composition of issuance. Issuance plans and auction announcement should include all detail, also in English language.

➢ Direct placements should be phased out. There should be clear criteria for accepting bids in auctions, the state should become a price taker in the market.

➢ ICSID agreement (linkage to a foreign clearing house) could catalyse foreign investor entry.

➢ A security borrowing facility operated by the ministry or within the clearing system could enable market making functions.

➢ Once there is a diverse set of investors: some form of primary dealer system, defining eligibility, privileges and obligations can be established.

➢ ‘Market making’ can be one such obligation, though needs to be adapted given the early stage market development, and may need to be suspended in times of market stress.

Broad priorities

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• EBCI/Vienna Initiative (2018): Report by the working group on Capital Markets Union.

• Georgia Capital Market Development Strategy (2016).

• GET Belarus (2017a): Foreign investors in the local bond market, PB 04/2017.

• GET Belarus (2017b): Linking international central securities depositories with local central depositories, Technical Note TN 02/2017.

• IMF (2001): Developing government bond markets – a handbook.

• IMF (2013): Local currency bond markets – a diagnostic framework.

• IMF and World Bank (2019): Developing a medium term debt management strategy framework - updated guidance note for country authorities.

• Jonasson, T. and M. Papaioannu (2018): A primer on managing sovereign debt-portfolio risks, IMF Working Paper no. 18/74.

References

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About the German Economic Team

C O N T A C T

Dmitry Chervyakov, Project Manager Belaruspoluschkin@berlin-economics.com

German Economic Team Tel: +49 30 / 20 61 34 64 0c/o BE Berlin Economics GmbH info@german-economic-team.comSchillerstraße 59 www.german-economic-team.com10627 Berlin

The German Economic Team (GET) advises the governments of Ukraine, Belarus, Moldova, Georgia andUzbekistan regarding the design of economic policy reform processes and a sustainable developmentof the economic framework. As part of the project we also work in other countries on selected topics.

In a continuous dialogue with high-level decision makers of the project countries, we identify currentproblems in economic policy and then provide concrete policy recommendations based onindependent analysis.

In addition, GET supports German institutions in the political, administrative and business sectors withits know-how and detailed knowledge of the region’s economies.

The German Economic Team is financed by the Federal Ministry of Economics and Energy. Theconsulting firm Berlin Economics has been commissioned with the implementation of the project.