By Scott Harman and Nikki Stefanelli, managing directors, benchmarks
Having previously examined the extent to which a country’s monetary policy can act as a barrier to entry for foreign government bond investors, we now turn to the role of sustained issuance, a topic that is also included as part of the Market, Macroeconomic and Regulatory category of our proposed FTSE Fixed Income Country Classification Framework.
The explicit reference to sustained issuance in our market accessibility criterion may appear axiomatic, but it is especially relevant for new markets that may qualify for concentrated index universes or account for a large portion of a multi-currency benchmark. While markets must meet a minimum size to be eligible for a given benchmark family, sustained issuance is included as a criterion for market accessibility as an objective proxy for replicability and liquidity.
Incorporation of this factor is intended to address the sub-optimal scenario where a market is added to an index and issuance subsequently slows markedly (or ceases entirely), thwarting an index user’s ability to manage a benchmark with minimal tracking error. This may occur in absolute terms as a lack of supply across the entire yield curve, a phenomenon that is more likely in concentrated global inflation-linked or emerging market universes. It may alternatively be manifested in specific parts of the yield curve if issuance ceases at the long-end, for example, causing longer-dated bonds to become less liquid. Given the trend towards emerging markets crossing over to more mainstream high-grade global benchmarks, such as the FTSE World Government Bond Index (WGBI) and the FTSE World Inflation-Linked Securities Index (WorldILSI), the risk of diminishing issuance is a broader consideration.
A notable example is the case of Poland’s linker market, which shrunk significantly from PLN25B at the end of 2013 to one PLN inflation linked security outstanding with a par value of PLN3.9bn as of September 2018. This was largely due to structural changes in the Polish pension fund industry, which reduced the amount of linkers significantly to this single issue as privately managed, state-mandated pension funds transferred a large part of their government linker bonds back to the government and these bonds were subsequently retired. After these changes, foreign ownership in Polish government linkers increased, but there has been no new Polish linker issuance since the pension reforms five years ago, and the prospect of future issuance seems low. The case of Poland shows that market events may lead to scenarios where the replicability of a benchmark is compromised by significantly impaired liquidity or the unlikely probability of future issuance.
Another potential consideration for investors is the debt market microstructure for a given country. From a fiduciary’s standpoint, a country’s heavy reliance on short term debt can magnify the impact of market shocks or cause a dislocation if too much debt becomes due at the same time. As we mentioned previously, index tracking problems can arise if issuance is no longer brought to market at particular tenors, causing difficulties for investors endeavoring to match the duration profile of a benchmark.
To elucidate the implications of duration mismatches, consider the case of the Russian government bond market. As Russia’s credit worthiness was on an upward trajectory before the invasion of Crimea, Russian government bonds (OFZs) were added to several global mainstream investment grade benchmarks. The entire universe (with the exception of bonds with less than one year to maturity) was included. However, passive managers found the exposure difficult to replicate as issuance of long-dated sinkable OFZs had ceased many years prior. It was challenging for index users to match the duration profile of the index since longer maturity bonds were not actively traded and tightly held by domestic asset owners. To account for compromised liquidity and replicability concerns, benchmarks now generally include fixed-rate bullet OFZs only and track shorter-dated securities where issuance activity is concentrated. It is reasonable to postulate that a commitment from issuers to sustain issuance, with varying maturities, appears to be an important consideration when assessing eligibility for global benchmarks.
Conversely, while many mature government bond issuers acknowledge the importance of maintaining a vibrant yield curve by issuing and re-opening debt instruments with a range of durations (classical examples among developed markets include the US and UK), there are smaller or emerging government bond markets which may simply never have a vibrant yield curve across multiple tenor points as their deficit financing requirements are minimal. Switzerland falls into this category and has recently left the FTSE World Government Bond Index (WGBI) owing to dwindling issuance. It could also be the case that some large, liquid issuers may simply never issue longer dated government bonds, and if this is a persistent feature of the market, investors may be comfortable with this market structure. The majority of issuance by Hong Kong, for example, has less than five years to maturity. Similarly, the market value weighted percentage of the 1-10 Year segment of the Chinese Government Bond (CGB) market is 83%, compared to 41%, for UK Gilts, which is a market of comparable size. Figure 1 shows a comparison of issuance across a range of government markets.
Source: FTSE Russell, data as of September 2018, China, Germany, United Kingdom, Malaysia, United States, South Africa are existing government bond markets represented by WBGI. Past performance is no guarantee of future results. Please see disclaimer for important legal disclosures.
We encourage market participants to provide their feedback on the importance of sustained issuance as a factor in calibrating the relative accessibility of a market, as well as the other factors included in our proposed fixed income country classification framework. View our consultation.
© 2018 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE GDCM”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”) and (7) The Yield Book Inc. (“YB”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE GDCM, MTS Next Limited, Mergent, FTSE FI and YB. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®” , “WorldBIG®”, “USBIG®”, “EuroBIG®”, “AusBIG®”, “The Yield Book®”, and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, FTSE GDCM, Mergent, FTSE FI or YB. “TMX®” is a registered trademark of TSX Inc. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell Indexes is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing contained in this document or accessible through FTSE Russell Indexes, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE GDCM, MTSNext, Mergent, FTSE FI, YB and/or their respective licensors.