Debt Market Development in Emerging Economies: Major Issues and Challenges

1
Debt Market Developmentin Emerging
EconomiesMajor Issues and Challenges

• WB/SEACEN Conference in Colombo, Sri Lanka
• June 9, 2004
• Tadashi Endo
• The World Bank

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Liquid Govt Securities Market

• Active short-term markets are conducive to
  anchoring yields of longer maturities and
  expanding the markets capacity of absorbing
  bonds of longer maturities.
• How is it feasible in emerging economy
  environments?

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GDP Bond Market SizeWhat is a Critical Mass?
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Sizable Enough for Liquidity?In case of Sri Lanka
Estimated Issue Sizes of Long/Medium-term Government Securities Estimated Issue Sizes of Long/Medium-term Government Securities Estimated Issue Sizes of Long/Medium-term Government Securities Estimated Issue Sizes of Long/Medium-term Government Securities Estimated Issue Sizes of Long/Medium-term Government Securities Estimated Issue Sizes of Long/Medium-term Government Securities
2003 GDP in USD mil. 14,401
Debt Capacity ( of GDP) (Securities only) 50
Total Public Debt (USD mil) (Securities only) 7,201
Allocations Short-term 25 1,800
Long/Medium-term 75 5,400
Maturity of bonds (yrs) 5 7 10
Issue Amount (US mil) Quarterly 270 193 135
If re-opened for a year. Annual 1,080 771 540
Assumptions Source WB staffs analysis Assumptions Source WB staffs analysis Assumptions Source WB staffs analysis Assumptions Source WB staffs analysis Assumptions Source WB staffs analysis Assumptions Source WB staffs 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.

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The Most Common Problem
Illiquid Secondary Market !
May be hard to find policy solutions by this
categorical approach !
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A 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

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Capital Market Profile peculiar to Emerging
Economies
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Economy for Wider Distribution of Govt
Securities (1)

• a) Y lt F A for banks to walk away from BH
• b) Y D gt F for non-banks to intermediate or
  for the end-investor to buy govt securities
• c) D lt Y - F lt 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

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Economy for Wider Distribution of Govt
Securities (2)

• a) Y lt F A for banks to walk away from BH
• 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 gt 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

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Expanded/Open Repo Market
Interbank Market
How to settle? Clearing a/c with Central
Bank? Who supervises new members? What are the
entry criteria?
Open Market
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Singapore expanded repo mkt.
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Insufficient Debt/Cash Management

• More use of direct instruments for monetary
  operations
• Inefficient market signaling
• Highly volatile interbank market
• ?
• More holdings of govt securities by banks
• Defensive against sudden and large market changes
• Easier (more predictable) liquidity management
  than a customer loan portfolio
• More dependence of institutional investors on
  banks

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Disincentive Tax Regime

• 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

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Gaps and Overlap of Regulation

• 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 industry
• 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

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Financing of Market Regulation Infrastructures
Who has financed reaching these points?
Discovery of public interests in capital markets
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From Equity honey moon to Debt quarrel
Capital Market Development Sequence Matrix

• 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.

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Differentiation of supervisory focus skill set
by 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?
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Stock Exchange 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
  collusion
• Real-time transaction reporting and price
  dissemination 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)
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Regulatory Strategyfor Non-Government Debt
Marketin Emerging Economies

• Private placements and quasi-private placements
  are quite relevant to emerging economy
  environments.
• Simpler documentation requirements may be
  considered for frequent issuers.

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Differentiate Regulation by type of offerings
Offering Type
Public Offerings
Private Placements
Quasi P/P (144A)
Investor Type
Institutional/Affluent Investors (Non-private
customers)
Retail Investors (Private customers)
Qualified Institutional Investors (Wholesale
players)
Disclosure Restrictions
Unregulated/Light-weight Disclosure Large
denomination Unlisted/Non-rated
Lightweight Disclosure Large denomination
Foreign Currency
Full Disclosure Small denomination Local
currency
Transfer-ability trading
Restricted tradability
OTC Trading among QIIs Exchange listing for
marketing purposes
Exchange OTC, Price reporting
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Affinity between Private Placements and Emerging
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.

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Simplify Documentationfor frequent issuers (vs
one-time issue)
Euro MTN
UK Issuance Programme
EU Prospectus Directive
Program Type
Master Prospectus (Periodically updated)
Registration (Periodically updated)
Programme Documentation (Periodically updated)
Basic Document
Pricing Supplement
Pricing Supplement
Securities Note
Additional document for a particular issue
Securities Summary
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Wrap-Up

1. Active open short-term securities markets
   including an open repo market (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 management 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

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Thank You!
Tadashi Endo
tendo_at_worldbank.org