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Poland's classic convergence play

14 Sep 2001

Poland's domestic bond market may be the largest among EU applicant states, but it is dominated by government securities. As at the end of May 2001, the outstanding amount of debt securities totalled Z132bn (Eu34.1bn), of which non-government offerings accounted for just Z15bn. However, with local institutional investors keen for an alternative supply of issues, hesitant steps are being taken to develop a public corporate bond market. Nick Parsons reports

Poland's budget deficit is such that by the end of August this year, the republic had needed to raise Z28bn (Eu7.2bn) through Treasury bonds and T-bills. That figure is scheduled to rise dramatically later in the year due to delays in privatisation and an unexpected budget shortfall.

This is good news for investors attracted by generous yields - at around 14% - for what is regarded as the classic EU convergence play. Investors may have been consolidating in recent months - partly because of political and economic uncertainty in the run up to the September 23 parliamentary elections - but many investors put Poland in territory somewhere between 'emerging markets' and the G7 nations. Poland provides higher returns than other first wave EU contenders such as Hungary and Czech Republic - which have more developed economies - but a similar limited risk (with the exception of currency risk, which is strong partly because of the involvement of international investors).

Polish government securities hog the limelight for Polish investor, too. That is not surprising in the context of the country's 8%-10% real interest rate environment. Government issues are exempt from tax and the expense of public trading on the stock exchange which corporates would have to pay.

This attractive stranglehold of the sovereign has inevitably held back the non-government market. "Investor demand is high for government securities in a country with such high real interest rates," says Agnieszka Czuba, director, financial markets department, at BRE Bank in Warsaw. "There is little incentive for professional investors to take credit risk when they can buy just Treasuries and earn a decent return."

She concludes: "A decrease in interest rates is necessary to motivate changes in investor appetite for corporate bonds."

"In Poland the government does not leave too much space for any other issuers," says Tomas Cerny, head of origination at Commerzbank Capital Markets in Prague. "All the banks are buying government securities, but if there was a really liquid blue chip corporate issue it might provide a nice alternative to the government market for the well developed insurance and pension fund sector and perhaps also the banks."

Anaemic corporate market

Over 70% of outstanding non-government issuance is commercial paper (CP), short term instruments featuring maturities of up to one year. According to Polish rating agency CERA, in the first half of 2001 the average maturity ranged from 48 days to 63 days.

As of mid-August, CP outstandings stood at Z12.6bn (Eu3.3bn) compared with Z3bn of outstandings for issues with maturities over one year, including convertible bonds, municipal bonds, and inter-company borrowings where the foreign multinational partner buys the domestic subsidiary's bonds. The biggest such deal was launched back in December 1999 when Thomson Polkolor raised Z700m (Eu180.8m) in two year bonds via SG. The largest transaction this year was IKEA's Z250m five year and 10 year deal led by ING Barings.

"These inter-company solutions provide easy flexibility and are a very nice form of financing," says Marta Antonowicz, director, capital markets, at Bank Handlowy w Warszawie, a member of Citigroup, in Warsaw. "But it is not marketable paper. It just sits in the company or on the bank's book and there is no inter-bank trading."

She continues: "The middle term market is more or less dead because there is no liquidity in the market due to the fact that there is no centralised clearing system and that private placements are not listed on the Warsaw stock exchange. Only government bonds are listed on the stock exchange, so it is hard to get enough information on the market."

There are two ways or organising issues: a public bond issue or a private placement. And a series of regulatory and cost obstacles make private placements the only effective way. There is one bond - for leasing company CLiF - that has been publicly registered on the exchange, but it would be going too far to say it was also traded on the exchange, since no prices are offered.

Antonowicz outlines the litany of procedures that are prohibitive to issuing a public bond in Poland: "If you do a public bond issue, you currently have to prepare a huge prospectus, which is longer and much more detailed than in the Euromarket and very expensive for the company." A prospectus has to be prepared for each issue, Antonowicz adds, which rules out MTN programmes.

"And that is only the first step," she continues. "Then you have to wait for the Polish Securities and Exchange Commission, which makes it costly to get the necessary permit. Then you have to pay extremely expensive fees to the National Depository of Securities (NDS), the body for clearing public issues. As a result, it does not make sense to clear the issue through NDS, especially for commercial paper, although maybe it might make sense for long term bonds."

After the NDS, says Antonowicz, comes the Warsaw Stock Exchange (WSE) to contend with. Issues must be traded via a brokerage house and the WSE currently charges 3bp on the transaction amount from each party of the transaction. "In contrast," she says, " the interbank market is much cheaper. Government bonds are excluded from having to trade through the stock exchange but public corporate bonds must be traded through the stock exchange. In addition, you must pay a 1% civil tax (previously known as stamp duty) on all deals except when one party is a bank - again government papers are excluded from this requirement."

The conclusion? "The result of all these problems is that Poland does not have a public corporate bond market."

Norbert Nowacki, head of debt capital markets at Deutsche Bank Polska, generally agrees: "The biggest problem in developing the public bond market is that it takes such a long time to do an issue and that the cost at the NDS is four or five times that of doing a private placement," he says. "The bond market has to develop. There are good names and the infrastructure is there, on the basis of CP at least, but settlement is very expensive and there is no alternative."

BRE Bank's Czuba estimates that with three year paper of Z100m, the fees associated with listing and servicing push up the cost by 30bp. "Those are significant costs when you consider that these are debt instruments not equity," she says. The problem is that many institutional investors have severe investment limits. They can invest up to 10% in listed corporate debt issues (compared with 100% in Treasuries) but some - for example open investment funds - are not allowed any non-listed bonds with a maturity of more than one year, says Czuba.

The Polish banks, via their mouthpiece the Polish Banking Association (PBA), have raised the question of whether one bank could become a clearing house for non-government debt - effectively taking over the role of the National Depository of Securities. Handlowy in particular is considering taking on the role.

"From the point of view of market liquidity, it would be a perfect tool," says Deutsche's Nowacki. "Everything is in place but it is far too expensive. The NDS would like huge volumes and huge fees but it is not being flexible. They have very expensive charges for everything but the market does not have big enough issues."

At present banks are making more profit by trading CP than on fees; many banks are hanging on in the CP market just to have a chance of securing the mandates for the juicier medium and long term bond issues - when they come.

Rare alternatives

One glimmer of hope comes from the European Investment Bank (EIB). The Luxembourg-based EU financial institution is scheduled to launch the first public bond issue off its Z3bn MTN programme in the autumn. It signed a framework agreement back in 1997 with the Polish government that gives the EIB equal regulatory treatment to the Polish government, thus freeing local institutional investors from their investment limits. Bank Handlowy was mandated in March 2000 and has been working on the origination since then. Bankers expect the inaugural issue to be a minimum Z500m.

The European Bank for Reconstruction and Development has been looking at possibilities too. "The EIB issue might be something really new, but it depends on the pricing of the paper," says Deutsche's Nowacki. "It will definitely be very attractive to qualified buyers - especially pension funds and insurance companies which have strict 5% limits on investments abroad - so any good credit in the domestic market would be attractive."

Two growing sectors of the non-government private placement market are the municipal bond market and securitisation transactions.

Muni bond issues grew by 20% in the first half of the year, with Szczecin putting out the largest, a Z30m 10 year issue. CERA points out that because of the budgetary planning process of municipalities, the majority of municipal governments decide to issue bonds in the second half of the year.

This market is dominated by two banks - PKO BP and Pekao SA. But many Polish banks do not bother with the market since it is financially not worth the effort unless you gain ancillary business from the municipal issuer. It has been suggested that a Z2m issue by Leszno in July earned its lead manager, Pekao SA, the grand sum of one grosz - the equivalent of the cent or the penny.

Structured transactions, in contrast, are more lucrative and are becoming increasingly popular. Earlier this year two trade receivables securitisation programmes were launched. PHARMAG-HM issued Z100m via BRE Bank while URTICA Finanse put out a Z50m issue through Bank Handlowy. Bankers expect to see leases and mortgages used to back transactions in the future.

Addressing liquidity

A major problem has been the lack of liquidity in the market - attributable partly to the lack of homogeneity in Polish corporate debt instruments. There has traditionally been no standard form of debt instrument, but the authorities last year responded to bankers' requests to clarify the legal basis for issuing bonds.

"The implementation of the new law will result in an increase in volume of paper outstanding in the market," says Antonowicz at Bank Handlowy, "and will also help create a centralised settlement and clearing system, which should simplify the procedures in the secondary market and improve liquidity."

That was the first step, she says. "The next challenge is to simplify disclosure. Then the third is to ask NDS and the stock exchange to cancel duties and cut fees.

"How long will it take?" she asks. "If you are an optimist, maybe a couple of months. If you are being pessimistic, maybe 12 years. After all, just changing the Bond Act took two years."

"The market has got potential," says Deutsche Bank's Nowacki. "We have the new regulation, which we hope will change attitudes to public bond issues. At least the authorities have started to consult the professionals - that is a very big step because before there was a closed number of specialists preparing this information."

The positive changes are driven by the need to meet EU criteria. The question is: can Poland have a well functioning bond market in place by the time it joins the EU? Certainly it lags well behind the Czech republic for medium term corporate bond issuance, which bankers assign to the fact that the authorities in Prague has passed much more efficient legislation for the development of not just an equity market but also a corporate bond market.

"In Poland, the first corporate papers were issued in 1994 and 1995, but in the time since then there have not been many," says Bank Handlowy's Antonowicz. She has a theory why. "I think bankers and the authorities were all busy with equity," she says. "Starting in the early 1990s, the Warsaw Stock Exchange started rising and there were all these new offerings which got retail investors involved. The Stock Exchange, the NDS and the banks were so proud of what was happening that they forgot about bonds."

Now is the time perhaps - with enthusiasm for the stock market dwindling - for the authorities to address issues holding back the development of a non-government bond market. *

14 Sep 2001