West pushing “valueless” state debt as policy: Ashmore

But this approach by developed-country governments is allowing emerging-market banks to take the lead in servicing investors in their local debt markets, argues Jan Dehn.
West pushing “valueless” state debt as policy: Ashmore

Western governments are purposefully seeking to get institutions to buy their “valueless” bonds – rather than those of less-indebted emerging markets – by introducing rules such as Basel III and Solvency II, says Jan Dehn, co-head of research at fund house Ashmore.

Yet these regulations are giving local EM banks a leg up over global rivals in terms of providing services to investors in their domestic debt markets, he adds. This is resulting in international investment banks less able or inclined to service investors in emerging markets.

Under the incoming rules, those seeking to trade bonds must set aside capital on a sliding scale depending on the credit quality of the issuer. That means it's a lot harder to lend money to countries such as the Philippines (rated B+ by Standard & Poor's) than the US (AA+, S&P).  

The stated aim is that events such as the subprime debacle don't happen again, Dehn tells AsianInvestor. However, “this is either very misguided and inept, or entirely deliberate”, he says, arguing it's the latter. "[Governments in Europe and the US] are so debt-saddled that they want to get people to buy their bonds.”

The US Federal Budget deficit, for example, is close to 8% of GDP, and the debt-to-GDP ratio has risen 42% in the past four years.

One way of controlling such deficits is by regulating what insurers and pension funds invest in, Dehn notes, through Solvency II and Basel III, respectively. “So they are forcing people to buy valueless and completely loss-making government paper. Maybe it's a fair thing to do.”

A "very senior European policymaker” has privately admitted that this is the aim, with a view to avoiding “inflicting pain all at once”, says Dehn. “It's a completely deliberate policy to hollow out everyone's pension and spread it out over many years.”

Moreover, global investment banks are becoming much less competitive and are being disintermediated in emerging markets as a result, he adds. “They are losing market share to local domestic banks – bonds are being traded where they are issued; that's where the business is.”

For example, some 80% of local-currency EM government debt is owned by local institutional investors, says Dehn. “If you want to trade bonds they're the ones you want to hang out with.”

As of the end of 2011, local-currency (LC) corporate debt accounted for $4.23 trillion (36%) of the $12 trillion of EM fixed-income assets. That figure is forecast by Ashmore to increase five-fold to $21.88 trillion by 2020, or 46% of the EM debt market, with the vast bulk of it expected to be traded locally, notes Dehn.

EM specialists such as HSBC and Standard Chartered will, of course, be important, but the trend is moving towards local firms taking over this business. That said, he adds, EM banks are still not a perfect substitute for big global banks – they don't have the same sized balance sheets or structuring capabilities, and are not so good at syndication as a result.

Another result of international banks' reduced activity in EM debt is that there is no LC corporate bond index, although Dehn expects to see such a benchmark created in the next year or two.

Even though the EM LC corporate debt market is now worth more than $4 trillion, there is no local index tracking it, he notes. “That's truly remarkable.” The reason is that banks "wonder if they should be spending money to build indices in markets they don't really trade any more".

But that is hindering the market's growth, says Dehn, since many argue that something isn't an asset class unless it has an index.

Ashmore, nevertheless, started the world's first EM LC corporate bond fund in 2011 without an index backing it, he points out.

It did the same with its global corporate high-yield product, which launched in 2007. JP Morgan subsequently put an index together, and Dehn hopes it will do likewise for LC corporate debt. If it doesn't, he expects that another firm will, with Ashmore speaking to two other banks about it.

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