debt market development in emerging economies: major issues and challenges wb/seacen conference in...
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Debt Market DevelopmentDebt Market Developmentin Emerging Economies:in Emerging Economies:
Major Issues and ChallengesMajor Issues and Challenges
WB/SEACEN Conference in Colombo, Sri LankaJune 9, 2004
Tadashi EndoThe World Bank
Liquid Govt Securities MarketLiquid Govt Securities Market
• Active short-term markets are conducive to anchoring yields of longer maturities and expanding the market’s capacity of absorbing bonds of longer maturities.
• How is it feasible in emerging economy environments?
3
GDP & Bond Market SizeWhat is a “Critical Mass”?
Size of Bond Markets (% of GDP)
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
0 20 40 60 80 100 120 140
Log
GD
P (
in U
S$
Bil
.)
Sri Lanka = US$ 14.4 bil. (log10 of 1.16), 37% of GDP
US$ 64 (log10 of 1.81)
However, low correlation in emerging markets:• may reflect difference between the periods before and after capital accumulation; and/or• may suggest the potential that a successful market development will further drive
economic development.
4
Sizable Enough for Liquidity?Sizable Enough for Liquidity?In case of Sri LankaIn case of Sri Lanka
Estimated Issue Sizes of Long/Medium-term Government Securities2003 GDP in USD mil. 14,401Debt Capacity (% of GDP)* (Securities only) 50%Total Public Debt (USD mil) (Securities only) 7,201Allocations* Short-term 25% 1,800
Long/Medium-term 75% 5,400Maturity of bonds (yrs)* 5 7 10Issue Amount (US$ mil) Quarterly 270 193 135
If re-opened for a year…. Annual 1,080 771 540* AssumptionsSource: WB staff’s analysis
The size may be still modest even if an issue size is aggregated by re-opening of four quarterly issues, compared to….
– France, Germany, Japan, US = approx. US$ 5 bil.– Dutch, Portuguese….= approx. US$ 3 bil.– Singapore = approx. US$ 1.2-1.5 bil.
5
The Most Common ProblemThe Most Common Problem
Illiquid Secondary Market !
The lack of or Underdeveloped……• Money market• Primary dealership• Institutional investors (contractual savings)
……. Every prerequisite
A common way of searching for causes of the illiquidity is ….
May be hard to find policy solutions by this categorical approach !
6
A Symptomatic ApproachA Symptomatic Approach
• High inflation and/or depreciating currency
• Predominance of commercial banks
• Excess liquidity
• The lack of debt/cash management
• Disincentive tax regime
• Gaps and overlap of regulation
• Stock exchange vs OTC
Industry structure
Policy consistency
Market microstructure
7
Capital Market Profile peculiar to Capital Market Profile peculiar to Emerging EconomiesEmerging Economies
Income level is low, and households are predominantly dependent on bank deposits.
Economy is small.
Non-life overweighs life.
Pension funds are small.
Informal economy is sizable.
Market Infrastructure
Informaleconomy
Pension funds
Life
insurance
Individuals
Non-lifeinsurance
Foreign-owned
companies
Government
State-owned enterprises
Local
companies
Demand Supply Local cos are p
redominantly dependent on bank loans.
Foreign-owned companies are dominant, and rely less on local financing.
SOEs remain substantial.
Govt crowds out the private sector.
Inactive repo market Long-established central ban
k vs new-born cap. market regulator
Capital-rich banks vs poorly-capitalized broker/dealers
Unstable Macroeconomic Environments
8
EconomyEconomy for for Wider Distribution Wider Distribution of Govt Securities (1)of Govt Securities (1)
• a) Y < F + A for banks to walk away from B&H• b) Y – D > F for non-banks to intermediate or for
the end-investor to buy govt securities
• c) D < Y - F < A
Where,Y: yields on government securities
F: funding/opportunity costs of govt securities holdings
A: Banks’ administrative costs of govt securities holdings
D: Non-banks’ distribution costs of govt securities
9
EconomyEconomy for for Wider Distribution Wider Distribution of Govt Securities (2)of Govt Securities (2)
a) Y < F + A for banks to walk away from B&H • The entry of competent investment or merchant banks Y↓• The investor is offered safe cash management products yielding better than
bank deposits F↑
b) Y – D > F for non-banks to intermediate or for the end-investor to buy govt securities
• Non-competitive bids (competitive bidding is a costly exercise.) D↓• A competent but small investment bank without retail functions D↓• Lower opportunity costs of not depositing to the end-investor F↓• Lower funding costs to the distributor of government securities F↓
Recommended Policy Actions (But, be country-specific)• The development of competent non-banks• A parent-subsidiary model of universal banking• Electronic distribution
10
Expanded/Open Repo MarketExpanded/Open Repo Market
Interbank MarketInterbank Market
Bond portfolio funding, hedging, cash management, etc.
New Intermediaries
Open MarketOpen MarketHow to settle?Clearing a/c with Central Bank?Who supervises new members?What are the entry criteria?
Cash management, hedging, etc.
End-investors: corporations, SOEs, insurance cos, pension funds, mutual funds, etc.
Customer repos
Intermediaries: Banks.
Liquidity management, etc.
Interbank reposCentral bank repos
Central BankCentral Bank
11
Singapore expanded repo mkt.
-
500
1,000
1,500
2,000
2,500
3,000
1995 1996 1997 1998 1999 2000 2001 2002
Ave
rage
Dai
ly T
urno
ver
(S$
mil)
Repos
Outright purchases & sales Lifting of repo size
restriction (11/99)
Repo expansion to offshore banks & non-residents (5/00)
12
Insufficient Debt/Cash Management
• More use of direct instruments for monetary operations
• Inefficient market signaling• Highly volatile interbank market
▼1. More holdings of govt securities by banks
– Defensive against sudden and large market changes– Easier (more predictable) liquidity management than a cust
omer loan portfolio2. More dependence of institutional investors on banks
13
Disincentive Disincentive TTax ax RRegimeegime
• Manage fiscal constraints thoughtfully
• Tax incentive/disincentive policy designing, structuring and management in line with the debt market development policies.
• Transaction taxes
• May fragment the market
• May discourage contractual savings
14
Gaps and Gaps and OOverlap of verlap of RRegulationegulation
• The long-established and resourceful central bank vs the less experienced and resource-constrained capital market regulator
• Insufficient coordination: from “Equity honey moon” possibly to “Debt quarrel”
• A shift of financial supervision and regulation model from specialist and separatist regulators to a unified/single regulator– Responding to changing business mode and structure of the financial indus
try
– The skills-mix of the unified regulator needs to be carefully balanced.
• A stop-gap solution Memo of Understanding to be executed and publicly disclosed
15
Market serving public & private interests
Market serving private interests only
Capital markets in developed countries
Who has financed reaching these points?
Discovery of public interestsin capital markets
Capital markets in developing countries
Short period (10-20 yrs)
Long period (100-200 yrs)
Financing of Market Regulation Financing of Market Regulation & Infrastructures& Infrastructures
16
From “Equity honey moon” From “Equity honey moon” to “Debt quarrel”to “Debt quarrel”
• Brokerage/Stock is simple enough to accommodate a double reg. agency model.
• As service/product lines evolve, the cap market regulation may overlap the traditional jurisdiction of the central bank (i.e. credit concerns) .
• A single reg. agency model may work better.
Capital Market Development Sequence Matrix
Deriva-tivesBondsStocks
521BrokerageAgency business
522Dealing
533Under-writingPrincipal
business
544Asset manage-ment
544M&AAdvisory business
Deriva-tivesBondsStocks
521BrokerageAgency business
522Dealing
533Under-writingPrincipal
business
544Asset manage-ment
544M&AAdvisory business
Service linesMarket development direction
Product linesMarket development direction
17
DifferentiationDifferentiation of of supervisory focussupervisory focus & skill set & skill set by types of capitalby types of capital
Type of capital Objective to be served End-investors
Primary regulatory
method
Primary regulator
Well-protected (safe) capital
Liquidity & solvency management in the national economy
Depositors Prudential regulation of deposit taking institutions
Central Bank
Risk-involved capital
Promotion of investments in the national economy
Securities holders
Disclosure of issuers and products
Capital Market Regulator
Can the central bank do both?
18
Stock Stock EExchange vs OTCxchange vs OTC
• Market making (quote-driven) is indispensable.• Market making is costly and risky.• Compensated by primary market previleges• Tends to be nontrasparent and may be liable to collusio
n• Real-time transaction reporting and price disseminatio
n system (e.g. RTRS*, TRACE**, MunicipalBonds.com) – A web-based method may be suitable for an emerging economy.
* Real-Time Transaction Reporting System (MSRB), ** Trade Reporting and Compliance Engine (NASD)
Regulatory StrategyRegulatory Strategyfor Non-Government Debt Marketfor Non-Government Debt Market
in Emerging Economiesin Emerging Economies
• Private placements and quasi-private placements are quite relevant to emerging economy environments.
• Simpler documentation requirements may be considered for frequent issuers.
20
Institutional/Affluent Investors (Non-privat
e customers)
Unregulated/Light-weight Disclosure
Large denominationUnlisted/Non-rated
Restricted tradability
Private Placements
Retail Investors (Private customers)
Qualified Institutional Investors (Wholesale
players)
Lightweight Disclosure
Large denomination & Foreign Currency
Full DisclosureSmall denomination
& Local currency
OTC Trading among QIIs
Exchange listing for marketing purposes
Exchange & OTC, Price reporting
Quasi P/P (144A) Public Offerings
Investor Type
Disclosure & Restrictio
ns
Transfer-ability & tradin
g
Offering Type
Differentiate Regulation by type of offerings
21
Affinity between Private Placements and Affinity between Private Placements and Emerging Economy EnvironmentsEmerging Economy Environments
• Information problem in emerging economies– a close due diligence, – a number of strict covenants, and,– careful monitoring
• Predominance of bank loan financing– Short maturity– Floating rates
• Traditional private placements• Frequently violated covenants and flexible re-negotiation• A small number of institutional investors• Issuers and investors often know each other.• Tradability is secondary or even undesirable• No registration, but ex-post facto reporting may be desirable.
Unsatisfied needs of local/regional enterprises
22
Master Prospectus(Periodically updated)
Pricing Supplement
Euro MTN
Registration (Periodically updated)
Programme Documentation
(Periodically updated)
Pricing Supplement Securities Note
Securities Summary
UK Issuance Programme
EU Prospectus Directive
Basic Document
Additional document for a particular
issue
Program Type
Simplify Documentationfor frequent issuers (vs one-time issue)
23
Wrap-UpWrap-Up1. Active open short-term securities markets including an open repo ma
rket (esp. an customer repo market) anchor yields of longer maturities.
2. Competent non-bank intermediaries and/or a parent-subsidiary model of universal banking are highly desirable.
3. Debt/cash management operations need to be kept well-streamlined.4. Tax incentive/disincentive policy designing, structuring and managem
ent should be in line with the debt market development policies. 5. A unified/single regulator model may be a legitimate choice.6. OTC with a real-time transaction reporting and price dissemination
system 7. Private placements may be a valid solution for information problem.8. Simpler documentation requirements may be considered for frequent
issuers
