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This paper was prepared for the conference “Restructuring and Strengthening the Korean Bond Market in a Global Economy,” organized by the East-West Center and the Korea Securities Supervisory Board that was held in Honolulu, Hawaii, August 5-8, 1998. R. Todd Smith is Associate Professor, Department of Economics, University of Alberta, Edmonton, Canada, and was a Visiting Scholar in the Research Department. The authors would like to thank Lee-Jay Cho, Lewis Freitas, Charles Kramer, Yoon Shik Park, and other conference participants for helpful comments.
For an analysis of how the introduction of the euro might affect the development of European-wide securities markets see Prati and Schinasi (1997).
Some central governments in the advanced economies do tap foreign fixed-income markets and do issue foreign currency debt securities. Italy, for example, has historically had an active foreign currency debt portfolio for general funding purposes, and Canada issues foreign currency debt for foreign exchange reserve management. Regional governments in some countries (e.g. Canada) are large issuers of foreign currency debt securities; this is largely what underlies the figures on public-sector international debt securities reported in Table 2.
As of January 1, 1997, repurchase agreements with a maturity of up to one year are exempted from reserve requirements (see Bundesbank Press Release 26/02/98).
Since 1993, a legal basis for repos has been defined.
The U.K. domestic market for private debt securities has largely become integrated with the Euromarket. Thus, one ought to exercise caution when interpreting statistics on the size or importance of the U.K. domestic market.
International issues are debt securities other than those issued by residents in domestic currency: this includes non-home-currency debt issued by residents, and all debt issued by nonresidents (whether home-currency or not).
These figures are from the Federal Reserve Bulletin (March 1998).
These figures refer to the dollar value of purchases on the secondary market as a ratio to the outstanding volume of corporate bonds. The source is Smith (1995).
The following discussion draws heavily from “Government Securities Markets in Industrial Countries”, Chapter V in Goldstein and Folkerts-Landau (1994).
See Cassard and Folkerts-Landau (1997) for a discussion of the management of sovereign assets and liabilities.
These figures were calculated from data obtained from the OECD and from the IMF’s World Economic Outlook databank.
See the Glossary for a definition of the winners’ curse.
A benchmark establishes a reference price or yield for a given maturity that is useful for pricing or evaluating yields on other fixed income securities with similar maturities.
The Investment Company Act provides the U.S. Securities and Exchange Commission with the mandate to govern mutual funds.
Tier 1 paper is defined as having the top short-term ratings from two recognized rating agencies, whereas Tier 2 paper is all other paper.
See, for example, International Financial Law Review (1993). Issuers in the Euromarket must comply with regulations specific to issuance in the Euromarket as well as the regulatory requirements of all countries in which the securities are to be sold. The primary market in Eurobonds is governed by a set of rules established by the International Primary Markets Association (IPMA), a Self Regulating Organization (SRO) established in 1984 as a voluntary organization of some 50 issuing houses to promote standards in the primary market in Eurobonds in documentation, communication, information disclosure and syndication practice (for further details see Clarke (1990)). The oversight and regulation of Eurobond secondary markets is also done by an SRO, the International Securities Market Association (ISMA)—formerly the Association of International Bond Dealers (AIDB)—established in 1969 by 150 banks active in the market. This organization has recently acquired status as an investment exchange under the U.K.’s Financial Services Act (FSA); prior to recognition as a regulatory authority under the FSA, ISMA regulated the secondary Eurobond markets purely on a voluntary basis.
Indeed, in Japan, bond lending was not authorized until 1989.
This requirement has subsequently been reduced in a series of steps.
Annexes A and B to IOSCO (1998) contain a list of IOSCO publications dealing with specific topics in supervision and regulation of securities markets.
See Karp and Koike (1990) for example. A cornerstone of bond issuance criteria in Japan was collateralization: the first uncollateralized bond was not issued in Japan until 1979. The bond issuance regulations required that only fully secured bonds could be issued, and even then only up to a stringent maximum amount (essentially determined by a firm’s equity capital). Further, only “trustee banks” were permitted to manage the relevant collateral (in exchange for a handsome fee). The consequence of these regulations was that bank loans provided the only financially viable source of external debt finance for most Japanese firms. Indeed, issuers of bonds were for the most part electric utilities and Nippon Telegraph and Telephone (NTT). As recently as the late 1980s, for example, this small group of firms accounted for more than 99 percent of all corporate bond issues.
Stimulus to bond issuance as a financing tool for Japanese enterprises has been provided by a large number of regulatory changes over the past decade or so. Some of the key regulatory changes to the corporate bond markets include the permission to issue bonds in foreign markets without explicit government approval, the issuance of unsecured bonds, the lifting of ceilings on bond issues by any firm, the lowering of the minimum required credit ratings, and the deregulation of commission fees. Deregulation of foreign exchange transactions including derivative instruments such as forward rate agreements and swaps have also contributed to the growth of securitized debt markets in Japan (see Osugi (1990), Takeda and Turner (1992), and Risk (1994) for additional discussion). The implementation of the “proposal method” to replace the BIAC’s practice of dictating the terms and conditions of a prospective bond issue has also been instrumental to the development of the Japanese corporate bond market. The proposal method allows firms to solicit proposals from underwriters on the terms and conditions and the associated fees rather than having these dictated by the bond issuance committee.
There may be up to three layers between the issuer and the final investors. The first layer is the managing group, comprised of a syndicate of firms with one (or more) being the lead manager (the “book runner”). The second layer is the underwriters, who perform an insurance function to the managing group by agreeing to buy the issues at a set price if they cannot be sold for a higher price in the market at the time of issue. The third layer is the selling group that markets the securities. Often the same firms perform more than one of these three functions. The price is only fixed at the end of the selling period, which generates some uncertainty for the issuer.
A much less-widely used method of issuing corporate debt securities, is to auction them. The advantage of an auction is that it eliminates the costs of underwriting, but on the other side of the ledger there is no obligation by some investment banks to make a secondary market in the issue. Moreover, this form of issuing securities is likely only practical for issuers that issue frequently and in large amounts—hence its widespread use for the issuance of government debt obligations.
Indeed, the pricing of corporate debt securities is often expressed in terms of the yield spread over the relevant government bond (i.e. same currency, same maturity) or possibly over (or under) an interbank funds rate (e.g. LIBOR). The convention in Eurodollar markets, for example, is to quote Eurobonds versus “on-the-run” Treasuries. If the benchmark bond does not exist in the relevant maturity, the practice is to quote versus the “interpolated” yield curve—an average of the yields on the two on-the-run Treasuries flanking the Eurobond’s maturity. This same methodology is used for Eurobonds in other currencies.
In particular, there has historically been inconsistencies between the ratings assigned to Japanese firms by Japanese rating agencies and some foreign rating agencies. Japanese rating agencies have apparently assigned consistently higher ratings than non-Japanese ratings (International Financing Review (1994)).
A key reason for listing bonds on an exchange is that some institutional investors may only invest in exchange-traded securities.
In the developed corporate debt securities markets, trading OTC may have a number of dealers in any single bond issue, but in practice the number of dealers of an issue is roughly proportional to the trading volume of the issue. The most liquid corporate bond issues in the United States, for example have about ten dealers, whereas illiquid bonds may have a single dealer.
In effect, bonds traded had to be hand delivered to one of the over 100 banks that act as registration agents and payment occurred well before delivery, thus introducing significant settlement risk (see Nikkei Weekly (1993, 1994a) and The Economist (1994)).
These figures are from the Investment Company Institute and the Treasury Bulletin (U.S. Department of the Treasury).
Investment Company Institute.