Section 6: Classification of Debt Securities
- International Monetary Fund
- Published Date:
- November 2009
6.1 Section 6 explains how debt securities statistics can be presented according to different classifications – by issuing sector and sub-sector, currency, maturity, interest rate and market. The Handbook also describes issues related to classification by default risk, although a specific classification scheme is not recommended for the detailed tables in Section 7 because further work is required in this area. Securitisation debt securities are described as a memorandum item, as shown in Section 7. These classifications and the memorandum item are useful for the analysis of debt securities markets from the perspective of monetary policy formulation and monitoring, financial integration, financial market regulation and financial stability.
6.2 The tables in Section 7 can be used to present statistics on debt securities issues with different classifications. The tables are designed to capture a wide range of debt securities characteristics, although only a subset of the cells in the tables might be relevant for a particular economy given the volume and structure of its debt securities issues and the regulations that govern the issuance and trade in these financial instruments.
Classification by issuing sector and sub-sector
6.3 From a monetary policy and financial stability perspective, it is important to analyse and understand the relative size of the different issuing sectors and sub-sectors, including non-residents’ issues. An indication of the openness of national capital markets may also be obtained from having accurate data on the issuance activity of non-residents in domestic markets.
Resident sectors for debt securities issues
6.4 As discussed in Section 3, the 2008 SNA groups resident institutional units into five mutually exclusive sectors – non-financial corporations, financial corporations, general government, households and non-profit institutions serving households (NPISH). The presentation tables in Section 7 show these sectors but combine households and NPISH into one group. The Handbook encourages this presentation of debt securities statistics.
6.5 Debt securities are predominantly issued by non-financial corporations, financial corporations and general government. Households and NPISH may be legally entitled to issue debt securities. In the case of households, debt securities can be issued to finance dwelling purchases.
Additional sub-sectors for debt securities issues
6.6 It may also be possible to report additional items for monetary policy and financial stability analysis.
6.7 The financial corporations sector could be broken down into debt securities issued by:
the central bank;
other money-issuing corporations comprising the sub-sectors “deposit-taking corporations except the central bank”, and some “money market funds” (MMF);27
securitisation corporations, and
other financial corporations, that is, financial corporations other than the central bank, other money-issuing corporations, and securitisation corporations.
6.8 The general government sector could be broken down into debt securities issued by:
the central government, and
other general government comprising state government, local government and social security funds.
6.9 Sometimes it is also analytically useful to aggregate debt securities issued across different statistical sectors. The public sector provides a broader coverage than the general government sector by combining debt securities issued by general government and public corporations, including the central bank.
Classification by currency
6.10 It is important to distinguish between currency of denomination and currency of settlement.28 Data on the currency composition of debt securities can be important for financial stability analysis. For example, potential currency mismatches can emerge in countries with debt denominated in foreign currencies that experience sudden and large exchange rate depreciation. These countries can be vulnerable to a large increase in domestic currency-denominated debt repayments, even if the initial level of debt is not high.
Definition of domestic and foreign currencies
6.11 Domestic currency is that which is legal tender in an economy and issued by the monetary authority for that economy, that is, either that of an individual economy or, in a currency union, that of the common currency area to which the economy belongs. All other currencies are foreign currencies (BPM6 3.95). Hence, statistics on debt securities issues can be classified according to whether issues are denominated in domestic currency or foreign currencies. These data can be aggregated to show debt securities issued in all currencies.
Currency of denomination and currency of settlement for debt securities issues
Currency of denomination
6.12 The currency of denomination is determined by the currency in which the value of positions and flows for debt securities issues are fixed, as specified in the contract between the institutional units. Accordingly, all cash flows are determined using the currency of denomination and, if necessary, converted into the domestic currency for the purpose of settlement. The currency of denomination is important for distinguishing transactions and revaluations (BPM6 3.98).
6.13 Debt securities issues can be denominated in domestic currency or foreign currencies. A further breakdown of debt securities issues denominated in several foreign currencies may be appropriate and may vary depending on the relative importance of the individual foreign currencies to a national economy or a monetary or economic union.
6.14 Debt securities with both their principal and coupon linked to a foreign currency are classified as though they are denominated in that foreign currency (BPM6 11.50 (b)).
Currency of settlement
6.15 The currency of settlement may be different from the currency of denomination. The currency of settlement refers to the currency into which the value of positions and flows for debt securities are converted each time settlement occurs (BPM6 3.99).
Classification by maturity
6.16 This classification addresses two different concepts of maturity – short-term and long-term maturity, and original and remaining maturity. These concepts can assist in the understanding of debt securities issuance activity, the debt position of issuers and their debt servicing capacity. Statistics on debt securities issues classified by maturity are also helpful for liquidity analysis.
Short-term and long-term maturity
6.17 Debt securities can be classified as having short-term or long-term maturity. A debt security with a short-term maturity is defined as one that is payable on demand29 or in one year or less. A debt security with a long-term maturity is defined as one that is payable in more than one year or with no stated maturity (BPM6 5.103).
6.18 It is also possible to break down statistics on long-term debt securities issues into four sub-items:
more than one year and up to and including two years;
more than two years and up to and including five years;
more than five years and up to and including ten years, and
more than ten years.
6.19 Original maturity is the period from the issue date until the final contractually scheduled payment (BPM6 5.104 (a)). On an original maturity basis, debt securities that mature in one year or less are classified as short term, even if they are issued under long-term facilities, such as note issuing facilities (NIF). Debt securities that mature in more than one year are classified as long term. This category also covers debt securities with optional maturity dates, the last of which is more than one year away, and those with indefinite maturity dates (2008 SNA 11.71).
6.20 Debt securities giving the creditor an option for early redemption are classified according to the original maturity date, but additional information on payments on the basis of the earliest repayment date should also be provided (External Debt Guide 6.33). Debt securities in which a certain portion of the issue is retired periodically (sinking fund provision) are classified according to the earliest date that the debt security is completely repaid. Debt securities that do not mature at all (perpetuities) are classified as long term.
Remaining (or residual) maturity
6.21 Remaining (or residual) maturity is the period from the reference date of a debt security until the final contractually scheduled payment (BPM6 5.104 (b)). Short-term debt securities with a remaining maturity of one year or less comprise those securities with an original maturity of one year or less and those with an original maturity of more than one year that will mature within one year.
Combining original and remaining maturity
6.22 Statistics on debt securities issues can combine measures in both original and remaining maturity terms accommodated by the following split:
(a) short term on an original maturity basis;
(b) long term on an original maturity basis that will mature in one year or less, and
(c) long term on an original maturity basis that will mature in more than one year.
6.23 Item (a) can be combined with item (b) to derive debt securities due within one year, that is, short-term debt securities on a remaining maturity basis. Alternatively, item (b) can be combined with item (c) to derive long-term debt securities on an original maturity basis.
Deciding on the maturity concept for debt securities issues
6.24 When deciding whether debt securities statistics should be recorded on an original or remaining maturity basis, it is important to consider the duration concept. Duration is the weighted average term to maturity of a debt security. It can be used to measure the impact on the value of a debt security that will result from a one percentage point change in interest rates. Unlike maturity, duration takes into account interest payments that occur throughout the life of the debt security. De facto, duration is a weighted average payment schedule.
Original versus remaining maturity
6.25 The original maturity concept is helpful in understanding issuance activity. For example, it is important to understand whether institutional units are borrowing short term or long term, and how the pattern is changing. It is likely that most countries present debt securities statistics based on this concept.
6.26 For the analysis of debt positions and debt servicing capacity, data on a remaining maturity basis may be preferred, since the concept is more closely related to duration. Given the tendency for debt securities with the same duration to have a similar yield, any differences in value are then due to the credit risk of the borrower, market liquidity, etc. Remaining maturity data are also particularly helpful for liquidity analysis.
6.27 The remaining maturity concept is recommended in this Handbook for long-term debt securities with a remaining maturity of one year or less, that is, item (b) above. All other data should be presented on an original maturity basis. In other words, as both original and remaining maturity measures have analytical interest, the Handbook encourages debt securities statistics to be presented for (a), (b), and (c) above.
Classification by interest rate
6.28 From a financial stability perspective, institutional units that issue a large share of debt securities with a variable interest rate may be exposed to more financial stress during periods of financial shocks.
Furthermore, the operation of the transmission mechanism of monetary policy may be influenced by the mix of fixed interest rate and variable interest rate debt securities. For example, if a large proportion of outstanding debt securities have a variable interest rate coupon, movements in market interest rates driven by changes to official interest rates can potentially make monetary policy more potent.
Fixed interest rate debt securities
6.29 For fixed interest rate debt securities, the contractual nominal coupon payments are fixed in terms of the currency of denomination for the life of the debt security or for a certain number of years. Therefore, from both the issuer’s and holder’s perspective, at the date of issue the timing and value of coupon payments and principal repayments are known. The features of such debt securities, as listed in the first column of Table 6.1, are described as common examples of fixed interest rate debt securities.
|Type of debt security|
|Issue price||100||<100 or||≪100||≪100||≪100||Generally||<100 or||<100 or||<100 or||<100 or||<100 or|
|Coupon payment dates||Fixed||Fixed||Fixed||—||—||Fixed||Fixed||Fixed||Fixed||Fixed||Fixed|
|Interest included in1||C||C & P||C & P||P||P||C||C & P||C & P||C & P||C & P||C & P|
|Change into equity securities||—||—||—||—||—||—||—||—||Issuer||Other corporation||—|
6.30 Fixed interest rate debt securities cover those listed below.
Plain debt securities are issued and redeemed at face value.30
Debt securities issued at a discount to their face value, with the exception of zero-coupon bonds (see below), and that usually pay no coupon. For example, Treasury bills, commercial paper, promissory notes, bill acceptances, and bill endorsements.
Deep discounted bonds have small coupon payments and are issued at a discount to face value.
Zero-coupon bonds are single-payment debt securities with no coupon payments. The bond is sold at a discount to its face value and the principal is repaid at maturity. Zero-coupon bonds may be created from fixed interest rate debt securities by “stripping off” the coupons, that is, by separating the coupons from the final principal payment of the security and trading them independently.
Separate trading of registered interest and principal of securities (STRIPS), or stripped debt securities, are securities that have been transformed from a principal amount with periodic interest coupons into a series of zero-coupon bonds, whose range of maturities matches the coupon payment dates and the redemption date of the principal amount.
Perpetual with a fixed interest rate, callable (redeemable) and puttable debt securities, and debt securities with sinking fund provision.
Convertible bonds, usually classified as fixed interest rate debt securities, may, at the option of the issuer (or the holder), be converted into the equity of the issuer, at which point they are classified as equity securities.
Exchangeable bonds are usually fixed interest rate securities with an embedded option allowing them to be exchanged for equity securities in a corporation other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under agreed conditions.
Debt securities interest that is linked to the credit rating of another borrower should be classified as fixed interest rate debt securities, as credit ratings do not change continuously in response to market conditions (BPM6 5.111).
6.31 Fixed interest rate debt securities may also include some financial instruments that are on the borderline between debt securities and other negotiable financial instruments.
Equity warrant bonds are debt securities that incorporate warrants, which give the holder the option to purchase equity in the issuer or another company during a predetermined period, or at a particular date and at a fixed contract price. The exercise of the equity warrant will normally increase the total funding of the issuer because the debt is not replaced by equity but remains outstanding until the date of its redemption.31 The warrant may be detachable and traded separately from the debt security. As a result, two separate financial instruments can be presented – the warrant, as a financial derivative, and the bond, as a debt security.
Subordinated bonds have a lower priority than an issuer’s other bonds in the event of liquidation. The terms of issue on some debt securities in the event of liquidation require them to be repaid before subordinated debt receives any payment. Since subordinated debt securities are repayable after these debt securities have been paid, they are riskier for the holder. Subordinated bonds usually have a lower credit rating than the debt securities that are repayable sooner.
Stapled instruments, which under their terms of issue are two or more different financial instruments (for example, ordinary equity securities and unsecured notes) coupled together for certain purposes, are usually treated as fixed interest rate debt securities and equity securities, where separately identified. However, they usually cannot be transferred separately either in the market or as the result of an over-the-counter transaction. A parcel consisting of one equity security and one or more notes is traded in the market as though it were a single security, although conceptually the components are regarded as separate. If the components cannot be separately identified, they should be classified according to the predominant component, either as debt securities or equity securities.
Variable interest rate debt securities
6.32 Variable interest rate debt securities have their coupon or principal payments (or both) linked to a general price index for goods and services (such as the CPI – consumer price index), interest rate (such as the LIBOR – the London interbank offered rate – or a bond yield) or asset price. The reference value fluctuates in response to market conditions. In Section 7, Table 7.5 reflects these different types, with a breakdown into three sub-categories: inflation-linked, interest rate-linked, and asset price-linked. The features of variable interest rate debt securities are listed in Table 6.2.
|Type of debt security|
|Issue price||<100 or||<100 or||<100 or||<100 or||<100 or||<100 or||<100 or >100|
|Coupon payment dates||Fixed||Fixed||Fixed||Fixed||Fixed||Fixed||Fixed|
|Interest included in2||C & P||C &P||C & P||C & P||C & P||C & P||C variable & P|
6.33 Variable interest rate debt securities include those issued as inflation-linked bonds, and asset price-linked bonds. The redemption value of an asset price-linked bond includes those linked to the price of a commodity.
6.34 In the case of interest rate-linked debt securities, the contractual nominal coupon payments are variable and are revised periodically according to the reference interest rate. Therefore, from both the issuer’s and holder’s perspective, at the date of issue the timing and value of coupon payments and principal repayments are uncertain.
6.35 A specific type of interest rate-linked debt security is a variable rate note (VRN). This note adopts the standard characteristics of a variable interest rate bond. However, whereas a standard characteristic of a variable interest rate bond is that it carries a fixed spread over a reference index, the spread over the reference interest rate on a VRN varies over time depending on the change in the perceived credit risk of the issue or issuer. VRN generally have a put option for the existing holders of notes to sell the issue back to the lead manager of the issuing syndicate at face value and at any interest payment date. For further details, see Annex 1.
Mixed interest rate debt securities
6.36 Mixed interest rate debt securities have both a fixed and variable coupon rate over their life and are classified as variable interest rate debt securities. They cover debt securities that have:
a fixed coupon and a variable coupon at the same time;
a fixed (or a variable) coupon until a reference point and then a variable (or a fixed) coupon from that reference point to the maturity date, or
coupon payments that are pre-fixed over the life of the debt securities but are not constant over time. They are called stepped debt securities.
Classification by market
6.37 This classification allows an understanding of the relative importance of debt securities issues by different resident sectors and non-residents across markets. It can also support analysis of the relative attractiveness of the domestic debt securities market compared with international markets, and the impact of structural changes in debt securities markets, such as deregulation, consolidation and financial innovation. In the absence of information on the currency denomination of debt securities, data on securities issued in international markets can provide a broad indication of the domestic-foreign currency composition of debt securities issues.
Domestic and international markets
6.38 Statistics on debt securities issues can be classified according to the markets where these securities are issued – domestic or international (or both) – which would be reflected in statistics covering all markets.
This classification is particularly important for emerging market economies, where connections between the two markets are in their early stages. While institutional units that are resident in emerging market economies usually issue debt securities in their domestic market, they do not always have access to international markets. In addition to making these economies more attractive to foreign investors, the liberalisation of the financial markets of these economies allows resident units to issue securities in international markets. This would induce an inflow of foreign capital, reduce the cost of borrowing for domestic institutional units, and promote economic growth. Non-resident units may issue debt securities in emerging market economies if they are permitted.
6.39 As financial markets become more open to foreign issuers and investors, the separation between domestic and international securities markets becomes less clear. This is particularly the case for institutional units that are resident in industrialised economies. They can usually raise funds by issuing debt securities in their domestic market or international markets (or both), which would be reflected in statistics covering all markets. At the same time, non-resident institutional units can issue debt securities in the domestic market. In these cases, the borderline between domestic and international markets is becoming unclear.
6.40 The presentation of statistics on debt securities issues classified by market will depend on the two approaches described in Section 1. The guidelines presented below are based on the External Debt Guide 6.21.
In the “residence of issuer” approach, debt securities issued by a resident of the same economy in which the security is issued are classified as domestic market issues, regardless of the currency of issue. All other issues are classified as those in international markets.
In the “location of issue” approach, all debt securities issued in that economy either by residents or non-residents are classified as domestic market issues, regardless of the currency of issue. In this approach, debt securities issued in international markets would be excluded by definition.32
6.41 If there is uncertainty over the market of issue, the three criteria stated below should be used in descending order of preference to determine whether a resident of an economy has issued a domestic or an international debt security (External Debt Guide 6.21).
The debt security is listed on a recognised exchange in the domestic economy (domestic issue) or in a foreign economy (international security).
The debt security has an International Security Identification Number (ISIN) with a country code the same as the legal domicile of the issuer, or is allocated a domestic security code by the domestic national numbering agency, or both (domestic security). Alternatively, the debt security has an ISIN with a country code different from the one for the country where the issuer is legally domiciled or an international security code issued by a foreign national numbering agency, or both (international security).
The security is issued in the domestic currency (domestic issue) or in a foreign currency (international issue).
Classification by default risk
6.42 As outlined in Section 2, a qualitative feature of debt securities refers to the default risk attached to them. Due to its relevance to monetary policy and financial stability analysis, it is important to outline some aspects concerning the possibility of classifying statistics on debt securities issues by default risk. Various methods include the use of external ratings and reference yield curves. This section does not provide a single classification scheme for statistics on debt securities issues by default risk.
Debt securities ratings as provided by credit rating agencies
6.43 External ratings by credit rating agencies assess the creditworthiness of an issuer with respect to its financial obligations. They provide an indication to holders of debt securities, as well as market analysts, about the issuer’s overall financial capacity and willingness to make scheduled coupon payments and principal repayments on a specific issue.
6.44 External ratings are designed by specialised national and international agencies based on risk analysis and ratings tools, which the agencies have developed. The ratings tools all use an alphabetical, ordinal structure to rate debt securities issues, although some agencies also use an alphanumerical grading scale. Their credit quality designations cover the range from high, through medium to low, which correspond respectively to the low, medium, and high probability of default (see Diagram 6.1).
Diagram 6.1Typical external ratings used by credit rating agencies for debt securities
6.45 Aggregate data on debt securities issues containing information on credit ratings are valuable for a number of reasons. First, they can assist policymakers and analysts to focus on sectors (or sub-sectors) containing institutional units that issue the riskiest debt securities. Second, they also help to identify the riskiest types of debt securities with a further breakdown by sub-categories or sub-positions. Both of these reasons are important in identifying possible contagion effects from default, with consequences for market liquidity and solvency, and transmission mechanism effects to the real economy. Third, they assist financial investment decisions with respect to transparency between creditors and debtors, and promote the efficient operation of the debt securities market. Fourth, ratings information provides a measure of the state of development of domestic and international securities markets in terms of their capacity to accommodate issuers of different credit standings.
6.46 Security-by-security (SBS) databases may contribute to an analysis of discrepancies in the multiple credit ratings across agencies and the tracking of their changes. However, there are challenges with regard to reconciling these differences and developing aggregate data, such as determining appropriate weights. Furthermore, future regulatory changes may affect the governance of existing credit rating agencies and the possible development of new credit ratings.
Reference yield curves
6.47 An alternative method for comparing and classifying the default risk of debt securities issuers is to use reference yield curves. These yield curves are a tool with which to derive information on the default risk structure of debt securities issues at remaining maturity. Debt securities that have a high credit quality are those securities with the lowest yield within homogenous classes of debt securities (currency, maturity, etc.). For example, the default risk of general government debt securities issues provides a benchmark for non-general government debt securities issues since the former securities are considered the least-risky issues. This is usually reflected in yield spreads between the respective debt issues, nationally as well as across countries.
6.48 Yield spreads may therefore be indicative of the relative creditworthiness of develop a statistical classification scheme for debt securities issues by default risk. For example, the lowest decile, or a lowest first percentile, could be used to define high credit individual issues. This could be used to quality debt securities. Again, SBS databases could facilitate the development of such yield curves and deciles.33
6.49 Apart from external ratings and reference yield curves, other methods may exist for developing a classification scheme for default risk. The ranking of debt securities on the basis of reference yield curves could also be compared or combined with the credit ratings applied to debt securities issues by rating agencies. Unlike the previous sections, the Handbook does not provide a single classification scheme for default risk. Further work is needed in this area. In particular, it will be necessary to identify whether it is possible to develop a conceptually sound classification scheme for statistics on debt securities issues by default risk.