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The role of a country’s issuance patterns in assessing fixed income market accessibility

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.

 

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