Growing up fast: CEEMEA bond market offers plenty of options
Few would have predicted that in the year following the election of Donald Trump, which was identified by all as a catastrophe for bond markets, the CEEMEA region would record its busiest year to date. But over and above volumes, the range of products and instruments on offer, from an increasingly wide range of issuers, shows the CEEMEA bond market is maturing nicely. By Virginia Furness.
CEEMEA debt markets have seen the busiest year to date since the golden year of 2013 when Russian bond issuance made up almost 60% of the market. At the end of May, bond issuance stood at $100.2bn, surpassing 2013’s record of $99.7bn over the same period. The market has digested all shapes and sizes of conventional bonds, but DCM bankers expect it to host an increasingly diverse range of products going forward.
“The last year, we have seen many firsts like Kuwait’s inaugural trade, Saudi’s debut and what is happening here is that the market is maturing,” says Jean-Marc Mercier, global co-head of DCM at HSBC in London. “People want to go to the right market for them, and issuers are looking increasingly at different formats. This year has been about innovation and debuts.”
Mercier points to the sukuk market as one that has seen particular progress this year. Jumbo sukuks from the likes of Saudi Arabia, and to a lesser extent Oman, have boosted 2017’s sukuk issuance in CEEMEA to $17.8bn, a record.
“We know it will be a record year for sukuk ” he says. “It is interesting to see how Saudi’s sukuk has opened up new accounts to the product. It is a deepening market and is very important for the region.”
Deutsche Bank’s David Greenbaum, who works in CEEMEA DCM, says global demographics will favour Islamic finance over the long term. “We’ll see increasing parity of treatment of sukuk by borrowers and investors over the next 10 years.”
Bankers also expect more private corporate issuance from the region, and from CEEMEA, as issuers look to move beyond their reliance on bank financing.
Stefan Weiler, head of CEEMEA DCM at JP Morgan in London, says international financing institutions (IFIs) will continue to play a big part in improving developing economies’ access to capital markets.
“IFIs are helping broaden the range of borrowers and products in the market,” he says. “[They can offer] partial guarantees, anchor orders and continue developing products to improve access to certain products and markets for EM borrowers. The IFC, for example, recently introduced an innovative loan programme that can bridge FIG borrowers to an international capital markets transaction.”
The IFC’s bridge programme offers borrowers a one year bridge loan, which if they cannot or do not repay, can be turned into a four year loan.
Broader use of such products has been held back by the strength of the market, argue some.
“Market conditions remain very receptive for EM borrowers in general,” says Weiler. “But if funding conditions were to turn more uncertain, borrowers would have a stronger incentive to look for this sort of product.”
IFIs have a role to play in meeting the predicted $5.2tr shortfall in infrastructure financing in the emerging markets. Institutions such as the European Bank for Reconstruction and Development are looking beyond the traditional public-private partnership model to the bond market to unlock access to private capital.
Infrastructure bonds are expected to play a larger role in meeting that need and already innovations are allowing for a more efficient deployment of IFI funds.
Turkey’s Elazig Hospital has led the way with a liquidity enhanced bond structured by the EBRD and the World Bank’s Multilateral Investment Guarantee Agency (MIGA). The structure unlocked access to private investment which was restricted due to Turkey’s sub-investment grade rating. The liquidity backstop in the form of an unfunded facility from the EBRD meant Moody’s rated the bond Baa2, giving it investment grade status, two notches above Turkey’s sovereign rating.
Green bond development
Hand in hand with the need for infrastructure comes the need for green infrastructure financing. Bankers expect the green bond market to deepen. China is already a prolific green issuer , but there has only been a spattering of issuance from CEEMEA and Latin America.
Poland led the way for sovereigns with a €750m 0.5% December 2021 and while a third party opinion was granted by Sustainalytics, the product was dubbed a “dirty green bond” by bankers on account on Poland’s continued reliance on coal as a source of income.
The World Economic Forum says $700bn of new investing is required every year to limit climate change to two degrees between now and 2100.
“Sustainable finance and green bonds are tools to transition the economy and we are convinced from our dialogue with investors and issuers that this market will grow fast,” said HSBC’s Mercier.
“If we want to transition to a green economy we need to be a bit more flexible,” he adds, referring to the sometimes restrictive categorisation of what constitutes green or SRI bonds.
As it stands, issuing green bonds is deemed to carry additional costs, as well as additional reputational risk. Here again the IFIs can take a leading role. The IFC and Amundi recently launched a $2bn fund to invest in emerging market financial bonds which aims to promote banks as intermediaries to green financing, and enable access to capital for smaller, often riskier projects in the developing world.
As more capital is allocated towards green products, borrowers could eventually see pricing benefits, says Weiler.
Panda eyes global future
Growth is also expected in the onshore Chinese market for foreign issuers — the Panda bond market — which has the potential to be the third largest funding market in the world, according to Mercier.
“The Panda market is shaping up to be one of the top three global markets along with Yankee and reverse Yankee [euro],” he says. “The overall size of the market means that it will be a giant. Already this year the onshore market is worth $150bn. It is an obvious area for issuers to look at for diversification.”
But so far Panda bond issuance has been limited, with bankers citing the difficulty of taking proceeds back offshore as a primary barrier to issuance.
“It will be driven by the regulators in China, and their openness to external borrowers and the ability to transfer the proceeds [of the deals] offshore,” says JPM’s Weiler. “The domestic market is very large and would be very attractive from a cost point of view, but many borrowers have found an issue with moving the proceeds offshore.”
HSBC’s Mercier identifies lack of name recognition as another key barrier and says issuers will need to roadshow across China, not just in Beijing and Shanghai, to fully benefit from that market.
Bankers also expect local currency markets to deepen. Many countries have adopted local capital market development as part of broader reform programmes, aimed at shoring up finances, reducing reliance on banks and improving access to funds for SMEs.
“In years of volatility, when the markets are not always open, it is good to have some sort of local liquidity,” said a head of CEEMEA syndicate. “Brazil is a great example. From the sovereign’s perspective, 80% of debt is issued in the local market which has helped them weather the storm.”
But even as the debt markets open up to new issuers and products, the regulatory squeeze may slow growth. Liquidity is expected to remain a concern with no let-up expected in bank regulation, despite hopes that the Trump administration in the US may unwind some of the more stringent restrictions on US banks.
Syndicate bankers point to the Market Abuse Regulation (MAR) as one which has had an impact on how they do business. “It is supposed to increase transparency but it does impact how we do business,” says one London-based syndicate banker. “You can’t ask investors for feedback any longer and it impacts the way you talk to sales.”
“There is also increasing scrutiny over the allocation process,” he adds. “The process is likely to become more transparent but also more automated.”
Banks are also set to implement Markets in Financial Instruments Directive II (MiFID II) which will affect how research and analyst desks are structured.