4-Global Bond Markets

8/4/2019 4-Global Bond Markets

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The Bond Market (also known as the debt, credit orfixed income market) is a financial market whereparticipants buy and sell debt securities, usually in theform of bonds.

As of 31st December, 2010, the size of the worldwidebond market (total debt outstanding) is an estimated $95 trillion, of which the size of the outstanding U.S.bond market debt was $ 37 trillion.

Nearly all of the $ 822 billion average daily tradingvolume in the U.S. bond market takes place between

the broker-dealers and large institutions in adecentralized, over-the-counter (OTC) market.However, a small number of bonds, primarilycorporate, are listed on exchanges.



Classification of the broader bond market into 5specific bond markets is done by theSecurities Industry & Financial MarketsAssociation (SIFMA)

Corporate

Government & Agency

Municipal

Mortgage Backed, Asset Backed andCollateralized Debt Obligation

Funding



Bond Market participants are similar toparticipants in most financial markets and areessentially either buyers (debt issuer) of funds

or sellers (institution) of funds and often both. Participants include:-

(1) Institutional Investors

(2) Governments(3) Traders

(4) Individuals



Because of the specificity of individual bondissues and the lack of liquidity in many smallerissues, the majority of outstanding bonds are

held by institutions like pension funds, banksand mutual funds. In the United States,approximately 10% of the market is currentlyheld by private individuals.



Domestic Bonds

Euro BondsForeign Bonds



They are issued (and traded) locally by adomestic borrower and are denominated in thelocal currency.

They usually carry less risk as the regulatoryand taxation requirements are usually knownto the investors or at least to their brokers andaccountants.



ABC Co. (incorporated & registered in US)issues a bond in US for placement in the USdomestic market (ie) only for the US resident

investors. The issue is underwritten by a syndicate of

American securities houses.

The issue is denominated in the currency of thetarget investors (ie) USD



Bonds issued or traded in a country using a currencyother than the one in which the bond isdenominated. This means that the bond uses acertain currency, but operates outside the jurisdictionof the central bank that issues that currency.

Euro Bonds are generally issued by MNCs andNational Governments to raise capital ininternational markets.

It is important to note that the term has nothing to do

with the currency EURO and that the prefix “EURO"is used more generally to refer to deposits outsidethe jurisdiction of the domestic central bank.

Eurobonds are often bearer bonds.



ABC Co. (a foreign corporation incorporated &registered in US) issues bonds to be placedinternationally (ie) say a British FMCG companymay issue a Euro Bond in Germany denominating

it in USD or an Italian Automobile company mightsell Euro Bonds issued in USD to investors living inEuropean countries.

The issue is underwritten by an international syndicateof securities houses.

The issue is denominated in any currency, includingeven the currency of the borrower’s country ofincorporation (ie) USD



They are issued (and traded) on a localmarket by a foreign borrower and aredenominated in the local currency.

Foreign bond issues and trading are underthe supervision of local market authorities.

For example, a bond denominated in USDollars that is issued in the United States by

the Government of Canada is a Foreign Bond.



ABC Co. (a foreign corporation registered &incorporated outside US) issues bonds in USfor placement in the US market alone.

The issue is underwritten by a syndicate of USsecurities houses.

The issue is denominated in the currency of thetarget investors (ie) USD



Straight or Fixed Income Bonds

Partly-paid Bonds

Zero-coupon Bonds

Floating Rate Notes (FRNs) Perpetual FRNs

Convertible Bonds

Bonds with Warrants Dual-Currency Bonds



Credit is important because individuals and corporations with poor creditwill have difficulty finding financing and most likely will have to paymore because of the risk of default.

Credit ratings are a tool used by lenders to determine the types of loansand rate of interest that can be extended to a potential borrower.

A corporation's credit rating is an assessment of whether it will be able to

meet its obligations to bond holders and other investors. Credit ratingsystems for corporations generally range from AAA or Aaa at the highend to D (for default) at the low end.

Your credit rating is an independent statistical evaluation of your abilityto repay debt based on your borrowing and repayment history.

If you always pay your bills on time, you are more likely to have goodcredit and therefore may receive favorable terms on a loan or credit card

such as relatively low finance charges. If your credit rating is poor because you have paid bills late or have

defaulted on a loan, you may be offered less favorable terms or may bedenied credit altogether.



A company that provides investors with assessmentsof an investment's risk. The issuers of investments,especially debt securities, pay credit rating agenciesto provide them with ratings.

A high rating indicates low risk and may thereforeencourage investors to buy a security. Additionally,banks may only invest in securities with a highrating from two or more credit rating agencies.

Fitch, S&P and Moody's are the three most

prominent global CRAs. The ratings have letter designations (such as AAA, B,CC) which represent the quality of a bond.

Bond ratings below BBB/Baa are called Junk Bonds.



The ratings given by CRAs are only their“opinions”.

Thus, they are not a recommendation to buy,

sell or hold a security and do not address thesuitability of an investment for an investor.

Regulators have “almost fully outsourced” toCRAs much of the responsibility for

assessing debt risk. For investors, ratings are a screening tool that

influences the composition of their portfoliosas well as their investment decisions.



The Basel 2 norms (ratings-based regulations)are much common in USA than acrossEurope.

Regulatory changes in banks’ capital

requirements under the Basel 2 norms haveresulted in a new role to credit ratings. The major objective of Basel 2 is to revise the

rules of the 1988 Basel Capital Accord so as toalign banks’ regulatory capital more closelywith their risks, taking account of progress inthe measurement and management of theserisks and the opportunities which theseprovide for strengthened supervision.



Under Pillar 1 of Basel 2, regulatory capitalrequirements for credit risk are calculated accordingto 2 alternative approaches:-

(1) The Standardized Approach – measurement of

credit risk is based on external credit assessmentsprovided by External Credit Assessment Institutionssuch as credit rating agencies or export creditagencies.

(2) The Internal Ratings-Based Approach – subject to

the supervisory approval as to the satisfaction ofcertain conditions, banks use their own ratingsystems to measure some or all of the determinantsof credit risk.



Under the Foundation Version (FV), bankscalculate the Probability of Default (PD) on thebasis of their own ratings but rely on theirsupervisors for the measures of the otherdeterminants of credit risk.

Under the Advanced Version (AV), banks alsoestimate their own measures of all thedeterminants of credit risk including the LossGiven Default (LGD) and Exposure at Default(EAD).



The processes and methods used to establish creditratings vary widely among CRAs.

Traditionally, CRAs have relied on a process based ona qualitative and quantitative assessment reviewed and

finalized by a rating committee. Recently, there has been increased reliance on

quantitative statistical models based on publiclyavailable data.

The key measure in credit risk models is the measureof the Probability of Default (PD) but exposure is alsodetermined by the expected timing of default and bythe Recovery Rate (RE) after the default has occurred.



Standard & Poor’s ratings seek to capture only theforward-looking probability of the occurrence ofdefault. They provide no assessment of the expectedtime of default or mode of default resolution andrecovery values.

Moody’s ratings focus on the Expected Loss (EL)which is a function of both PD and RE.

Fitch’s ratings also focus on both PD and RE. Theyhave a more explicitly hybrid character in thatanalysts are also reminded to be forward-looking

and to be alert to possible discontinuities betweenpast track records and future trends. The credit ratings of Moody’s and Standard & Poor’s

are assigned by rating committees and not byindividual analysts.



International Organization of Securities Commission (IOSCO) hasformulated a Code of Conduct Fundamentals for the working of CRAs.

The Code Fundamentals are designed to apply to any CRA and anyperson employed by a CRA in either in full-time or part-time capacity.

It focuses on transparency and disclosure in relation to CRAmethodologies, conflicts of interest, use of information, performance

and duties to the issuers and public, the role of CRA in structuredfinance transactions, etc. It does not dictate business models or governance but rather seeks to

provide the market with information to judge and assess the CRAactivities, performance and reliability.

The IOSCO Code of Conduct broadly covers the following 4 areas:-(1) Quality and integrity of the rating process(2) CRA’s independence and avoidance of conflicts of interest (3) CRA’s responsibilities towards the investing public and issuers (4) Disclosure of the Code of Conduct and communication with the market

participants

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4-Global Bond Markets