Transcript Document 7895196
Developing Efficient Market Infrastructure and Secondary Market of Government Bonds in Developing Countries
Johannesburg, South Africa June 19, 2003 Tadashi Endo
The World Bank
A primary prerequisite for bond market liquidity is a proper set of the demand and supply sides. A well organized market infrastructure is often secondary.
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Capital Market Profile peculiar to
Income level is low, and households are predominantly dependent on bank deposits.
Economy is small.
Non-life overweighs life.
Pension funds are small.
Informal economy is sizable.
Developing Economy
Demand Supply Individuals
Market Infrastructure
Non-life insurance Foreign owned companies Pension funds Informal economy Inefficient market Long-established central bank vs new-born cap. market regulator Capital-rich banks vs poorly capitalized broker/dealers State-owned enterprises
Government
Local cos are predominantly dependent on bank loans.
Foreign-owned companies are dominant, and rely less on local financing.
SOEs remain substantial.
Govt crowds out the private sector.
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Supply- & Demand-side Principles for Market Liquidity
Supply side Demand side Sizable, Regular, Stable (predictable), Transparent and Market-based
supply of bonds of
High quality, and Uniform characteristics,
and,
Many, Incessant, Competitive, and Diversified
demands for the bonds
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Public awareness/consensus about the roles of a government bond market is a key to reduce the direct trading costs of government bonds.
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Why Does Efficiency Matter? (1)
How much does trading affect total returns?
Trading in response to an interest rate decline An interest rate declines Get the initial investment back and a
CAPITAL GAIN
Reinvest them in a new opportunity for the remaining maturity How much do the total returns improve?
NOTHING!
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Why Does Efficiency Matter?(2)
How much does trading affect total returns?
Current coupon bonds Little Impact on Total Returns of 10-yr Bond
Interest Rate Change -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 4
-0.03% -0.02% -0.01% 0.00% 0.02% 0.03% 0.04%
Years to Maturity 5
-0.06% -0.04% -0.02% 0.00% 0.03% 0.05% 0.08%
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-0.13% -0.10% -0.07% -0.04% 0.00% 0.03% 0.07%
Over a yield curve ranging from 3% for 1 year to 8% for 10 years Coupon payments complicate cash flows Decomposable into discount CFs The YTM is the average YTM of component CFs.
Reinvestment makes little difference in total returns 7
Why Does Efficiency Matter?(3)
What is trading for? – Private interests
Trading per se is neutral to total returns, and never pays for trading costs without additional risk taking. Even a capital gain brings you nothing. Trading always eats up some yield.
Nonetheless, people trade for: • Hedging • • • Rebalancing Speculation Arbitrage in an unequilibrium market
Self-interests (Private interests)
in longer-term debt (volatility & trading opportunities) only at low trading costs 8
Why Does Efficiency Matter?(4)
What is trading for? – Public Interests Macroeconomic benefits
Lower financing costs of budget deficits Risk management facilities Financial asset pricing Signaling function for effective monetary policies Development of a corporate bond market
Public interests Trading costs
Brokerage commissions or bid/ask spreads Market impacts Fees Transaction taxes Opportunity costs • • • Dealers’ market (OTC) Clearing, settlement & depository Accounting
Awareness/Consensus must be formed.
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Why Does Efficiency Matter?(5)
A benefit: how much can you save?
Czech Hungary Malaysia* Poland Outstanding In 2001 US$ mil
3-5 yrs Government Bonds
Bid/Ask Spreads Tightest Median Market Impact Liquidity Premium Assumed cut 4,200 0.03%
0.09%
?% ?%
0.05%
10,300 0.35% 25,900 0.01% 10,000 0.04%
0.40% 0.30% 0.30%
?% ?% ?% Slovakia* Thailand* 4,700 0.10% 5,900 0.04%
0.20% 0.06%
?% ?% IFC Bond database: Apr 30, 2001 * Indicative quotes 10 ?% ?% ?% ?% ?%
0.20% 0.15% 0.15% 0.10% 0.03%
Calculated savings US$ mil
1.9 20.6 38.9 15.0 4.7 1.8
Why Does Efficiency Matter?
(6)
The basis for efficient primary markets Govt Bonds
Liquid
Secondary Market
Efficient
Primary Market
Corporate Bonds Secondary Market
Efficient
Primary Market
A liquid secondary market of govt bonds is the basis for the efficient primary markets of both govt and corporate bonds.
A policy weight of the secondary market of govt bonds is large.
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Key market infrastructures for market liquidity are a dealers’ market and an expanded repo market.
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Dealers’ Market (OTC)
Continuous readiness to trade
Market making obligations tied to Primary dealership privilege.
• • • Quote-driven (ready to trade) Inventory & capital Low cost funding (
For a market with at least several sizable issues.
Expanded repo market) Salespeople & interdealer brokers Electronic trading system • Cost and benefit tradeoff • • Transparency and competition Operational efficiency (linked to STP)
Otherwise, may be a call auction market.
Post-trade reporting 13
Expanded Repo Market (1)
An anchor and catalyst for debt markets Repo market
Short-selling Market making Must be active.
Expended/Open repo market
Open to non-bank institutions Non-bank intermediaries Links the open market to the interbank market ( Arbitrage Will improve banking) Japan, South Africa, Singapore, UK, etc.
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Expanded Repo Market (2)
An anchor and catalyst for debt markets
3,000 2,500 2,000 1,500 1,000 500 -
Outright purchases & seles Repos
1995 1996 1997 1998 1999 2000 2001 2002 15
Electronic Trading System (1)
Limited roles of an ETS in trading Trading Action Circle Components of Broking Strategic Part PLAN DO Operational Part SEE Order Execution Processing/ Back Office Decision Facilitation Consultation
Efficiency matters Effectiveness matters ETS is not enough to complete a trading action circle.
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Electronic Trading System (2)
Market and product suitability to an ETS
Growth rates for electronic trading may accelerate.
Small/modest Specific Complex Immature Sizable Unspecific Commoditized Mature Many emerging markets are here.
Screen-broked trading accounts for: • More than 90% of Yen/US$ forex • More than 40% of US Treasury bonds • 15-20% of JGBs Good for mature products/markets 17
Clearing, Settlement & Depository
for
quicker availability of bonds and funds DVP ( payment system) Rolling settlement Book-entry system “Fail” system Straight-through processing (STP) Linkage with int’l settlement systems Manually possible, but …… No
efficient
government bond market without a computerized central depository 18
Trading-neutral Accounting & Taxation
Trading-neutral accounting • Mark-to-market for trading portfolio • • • • Current coupons No submarket issues (market-based issues) Trading-neutral taxation • No transaction taxes No withholding tax No differentiation between interest and capital gain incomes No preferential treatments against liquidity 19
Efficiency & Systemic Risks
Stable Less stable Market efficiency As the market becomes more and more efficient, the whole system may be getting less stable and more vulnerable to shocks – increasing systemic risks Additional measures & costs to contain systemic risks –
e.g.
Real-Time Gross Settlement (RTGS) 20
“Mediocre” investors are an indispensable basis for liquidity. They need brokers for active trading.
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Role of Salespeople or Brokers (1)
Can efficiency alone create liquidity?
A market consists of: A small number of visionary investors, and, A large number of “mediocre” investors.
“Mediocre” investors are an indispensable basis for liquidity.
Salespeople or brokers play a critical role in the psychological and emotional process of mediocre investors.
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Role of Salespeople or Brokers (2)
Can efficiency alone create liquidity?
Institutional investors Broker Dealer Broker Dealer Broker Dealer Broker Dealer
Interdealer brokers
Broker Dealer Broker Dealer Broker Dealer Broker Dealer Interdealer brokers conduce to trading through: Price discovery Price improvement Broker-dealers (market makers) & their salespeople Institutional investors: Many “mediocre” investors A few visionary investors “Mediocre” Visionary 23
Role of Salespeople or Brokers (3)
Can efficiency alone create liquidity?
“Mediocre” institutional investors are laden with: Uncertainty, Accountability, Decision making anxiety, Post-decision making anxiety, and, need: Confidentiality, Stress control, and, Damage acceptability
Role of Salespeople or Brokers (4)
Can efficiency alone create liquidity?
PLAN Action Circle of Trading DO Salespeople or brokers take care of …..
SEE Components of Broking Order Execution Processing/ Back Office Decision Facilitation Consultation
Efficiency matters Effectiveness matters Human intermediaries compete the action circle of trading by facilitating trading decision.
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Liquidity
Role of Salespeople or Brokers (5)
Can efficiency alone create liquidity?
"Mediocre" institutional investors are: Price-takers, but NOT price-givers, and, need: Continuous “price discovery” services, Investment advice With human assurance, for active trading.
A rich source of
Liquidity
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Role of Salespeople or Brokers (6)
Can efficiency alone create liquidity?
In many DCs, human intermediation is more practical and effective in: driving the owners of intermediary networks to expand their business (Internalization of network effects), and generating
liquidity
in secondary markets of government bonds. Which is more valuable for the network owner: an aggregate of personalized information about inventors or dealers collected by salespeople or brokers, OR,
More Valuable!
investors or dealers’ trading information mechanically gathered through an electronic trading platform ?
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Wrap-Up
Liquid Market & Secondary Market Infrastructure .
A proper set of the demand and supply sides of a bond market is a primary prerequisite for bond market liquidity. A well-organized market infrastructure is often secondary to them.
Public awareness/consensus about the roles of a government bond market is a key to reduce the direct trading costs of government bonds.
Key market infrastructures for market liquidity are a dealers’ market and an expanded repo market.
“Mediocre” investors are an indispensable basis for liquidity. They need brokers for active trading.
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Thank You!
Tadashi Endo
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