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Monday, 18 December 2017

Building for tomorrow

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The European Bank for Reconstruction and Development cut its teeth helping drag Russia through the mess of 1998 to its current modern incarnation. Now it is working with other European and central Asian countries, reports Solomon Teague.

The European Bank for Reconstruction and Development is actively promoting local currency lending and capital markets development in its countries of operations, in Europe and central Asia. “Particular focus has been placed on larger countries, whose currencies will not or not imminently be joining the euro and where the swaps market is limited or non-existent” said Axel van Nederveen, treasurer at EBRD.

“A cross-currency swaps market allows investors and borrowers to mitigate the currency risk in their balance sheet without needing a domestic bond market,” said van Nederveen, who admitted the focus on the development of a domestic capital market may be seen by some countries as a lack of commitment to joining the euro. However, the more rigorous application of the rules for prospective new entrants than has been applied in the past means it is important that market developments are not in stasis in the interim, he said.

The development of a domestic investor base helps to insulate borrowers from the fickle attentions of international investors. Poland has made significant efforts to create a domestic bond investor base, despite the presence of an active swaps market and a commitment to euro-entry. Romania is trying to improve efficiency in the listing and trading process for domestic bonds to facilitate more activity.

“To date, secondary activity [in Romania’s domestic market] has been limited due to high fees – akin to what would be expected for an equity transaction – and restrictive regulation, for example, the inability to short sell,” said Isabelle Laurent, deputy treasurer and head of funding at the EBRD. “When such problems are resolved, it is likely there would be demand for Romanian debt, considering the relatively high interest rates prevailing there.”

But the development of a domestic bond market is not universally welcomed. “The advent of a bond market is often viewed as undermining the incumbent loan market and creating greater pricing transparency, which may squeeze loan margins,” said Laurent.

There is even a view in some quarters that the arrival of EBRD as a lender of local currency will squeeze out the existing banks operating there, despite evidence in Russia and elsewhere that its activities only serve to increase business across the board. “In Russia you now see syndicated loans as well as mortgage and consumer lending despite the emergence of a domestic bond market,” she said.

“Although there is demand, especially for long-dated assets for the growing domestic pension fund and insurance industries, efforts to facilitate domestic corporate bond issuance tend to be low on the agendas of emerging economies,” Laurent said, “partly due to a lack of any clear idea on how best to proceed in achieving this goal.”

“In several instances governments have worked hard to create a primary market without a commensurate effort in creating a secondary market to support it, displaying a lack of understanding in the mechanics of a functioning market,” said van Nederveen.

Van Nederveen cited Romania as a good example to follow. It has shown a willingness to work with EBRD to build its infrastructure, and once progress has been made – for example in finding the balance between flexibility and protection – EBRD will look to launch a domestic issue.

“All countries have their own unique problems and priorities in developing a domestic capital market,” said van Nederveen. And despite the differences there are common themes in the problems arising in different countries.

It is not uncommon, for example, for developing economies to make no distinction between bonds and equities from a regulatory perspective, despite the contrasting mechanics of the markets. A lack of distinction between retail and institutional investors is another recurring theme, meaning domestic bond issuance targeted to institutional investors in emerging economies is often saddled with burdensome regulation designed to protect the equity investments of vulnerable widows and orphans.

Central and Eastern European countries have a relative advantage in the development of their domestic capital markets in that they can see the work EBRD did with Russia between 1999 and its debut issue in 2005 as an example of the benefits of working with the bank. Similarly, EBRD has learned a lot from its previous work with Russia. “For many of the countries, which have already jumped through a number of the necessary hoops in order to achieve European accession, they are starting from a better position than Russia did,” van Nederveen added.

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