Insights on Policies to Promote Investor Base Diversification and Competition

Transcription

1 FCMCG, Capital Markets Practice Financial and Private Sector Development, World Bank Group Insights on Policies to Promote Investor Base Diversification and Competition Investor base diversification is a major pillar of the government bond market development agenda. It is critical to promote secondary market liquidity, and to enhance the flexibility and stability of the government s funding strategy. A large and diversified investor base is important for ensuring strong and stable demand for government debt securities. The investor base should ideally include both domestic and foreign investors and all types of institutions, ranging from commercial banks to insurance companies, pension funds, and mutual funds, as well as individual investors.promoting a heterogeneous investor base with different time horizons, risk preferences, and trading motives is vital for stimulating active trading and high liquidity. A heterogeneous investor base is also critical for enabling the government to execute its funding strategy under a wide range of market conditions. - Developing the Domestic Government Debt Market: From diagnostics to reform implementation, The World Bank, The 3 rd Annual Gemloc Investor-Country Conference and Advisory Services Workshop (Conference) provided a platform for emerging market (EM) debt managers, global and regional asset managers, and market development professionals to exchange ideas and collaborate on local currency bond market development issues. Under the overall theme of approaches for improving liquidity of government bond markets, several sessions delved in-depth into identifying policies and strategies to promote investor base diversification and competition. A survey of various country practices in this area was also conducted ahead of the Conference, with responses from 19 countries (17 EMs and two developed markets). 1 This note summarizes the survey results 2 and the Conference discussion on the topics of monitoring nonresident investors and diversifying the investor base beyond banks. 1 Responding emerging markets: Brazil, Costa Rica, Hungary, Kenya, Lebanon, Malaysia, Mexico, Morocco, Pakistan, Poland, Romania, South Africa, Sri Lanka, Tunisia, Turkey, Uruguay, and Vietnam; and developed markets: Belgium and Italy. 2 Reference materials on this topic are available on the Conference webpage at

2 I. Monitoring non-resident investors Summary of survey results 11 of 19 respondents identified either the overall market development or promoting secondary market liquidity as the two most significant reasons for the relevance of non-resident investor (NRI) participation for domestic market development. In most of the markets, NRI preference is concentrated on the shortterm and medium-term segments of the yield curve. In terms of NRI preferences, fixed-rate instruments dominate but floaters and linkers are also attractive in several markets. Most of the respondents perceive either the volatility of interest rates or exchange rate volatility as the two most relevant risk factors from NRI participation. Out of 19 countries, ten have incentives provided to attract NRIs, and only four have regulations or barriers designed to control NRI participation. Out of 19 countries, only four have an optimal ratio of domestic debt held by NRIs as percentage of total domestic debt, which ranges between 10-20%. The majority of the respondents identified either the yield curve segment of participation or timely information on stock and flow of NRI as the most important priorities in monitoring NRI participation. Synopsis of conference discussion The session was conducted in a question and answer format and included general discussion from the floor. It provided an opportunity for debt managers to articulate their concerns and share feedback on monitoring non-resident investors (NRI), interactions with investor relations units, and potential impacts on debt management and issuance strategy. The discussion centered around three key questions: What are the benefits and drawbacks of NRI? Is there an optimal size? What is relevant to monitor and what is feasible to obtain? How can the information on NRIs be used in terms of impacts on issuance policy, auctions calendar, instrument choice and placement schemes? The main highlights of the session included: There is not much diversity in the responses concerning the benefits of NRI participation, which are all quite predictable. NRI participation in local markets contributes to the diversification of investor base, and lower the cost of funding via increased competition. Increased liquidity, financial innovation, and leverage for market development are three other main areas that might benefit from NRI participation in addition to its potential to create demand for longer maturities. The assessment of the drawbacks of NRI participation received quite uniform responses that tended to be concentrated on foreign exchange volatility and capital outflows. While opportunities are abundant and vary with market characteristics, benefits typically come with trade-offs such as FX volatility, contagion of global events, and change in investor sentiment. An important issue for most of the countries is the sudden outflow of capital. The strength of domestic investor base, the composition of foreign investor base, and the type of invested assets are important to counterbalance the disruptive effects of sudden outflows. There is no optimal ratio as long as it s stable and manageable, but basically it is a function of how much a large NRI base could disrupt the local market. There is also strong consensus on what is relevant to monitor. Geographical distribution is relevant and quite feasible in most of the countries with no apparent obstacles. The type of investor is very relevant to monitor however it s difficult to get as the breakdowns of the different funds managed by institutional investors are not available in some cases. An insight provided by the representatives of the investors is to 2

3 identifying the type of funds by asking the custodians the time horizon of the investments, e.g., if more than 3 months. As for the sources of the information, several countries are making a differentiation between stocks and flows. Most of the respondent countries are getting flows information from primary dealers or syndications in the primary market; and from the primary dealers in the secondary market. Most of the respondent countries don t have standardized formats to collect the information but they are planning to do so. As for stocks, custodians and CSDs are the main data providers. Investor relations units are also data sources, both for stocks and flows. The responses concerning the usage of the information on NRIs are rather disperse. Most of the respondent DMOs use the collected information in the selection of instruments and maturities. A few of them use the information to decide on the timing of the issuances. Several respondent countries use the information for targeted communications. Placement mechanisms (only in one country), buy-back strategies (in Brazil), and market development are other areas where this information is used. II. Diversifying the investor base beyond banks Summary of survey results A majority of survey respondents consider diversifying the investor base highly relevant. However, the priority in terms of investor segments to reach or expand varied by country. Not surprisingly, institutional investors such as pension funds and insurance companies were considered relatively more important to develop, while at least four countries identified developing the retail investor segment as the most important to them. Eight countries already had retail debt programs with the primary objectives being democratizing access to public debt and diversifying the investor base. Countries face a host of obstacles in the way of investor base diversification. 14 respondents ranked either the macro environment level and volatility of interest rates, level of savings, etc or the dominance of banks in their markets as the two most important challenges. Regulatory hurdles and lack of liquidity were some of the other challenges identified. A majority of respondents also stated that their debt management office (DMO) has proactive policies to reach different investor segments. However, the primary mechanism to do so seems to be informal consultations with investors. Several countries also provide incentives to primary dealers (PDs) to distribute securities more widely to clients, and some maintain formal investor relations units and investor meeting schedules. Respondents identified a few complementary policies, outside the scope of the DMO, which could help diversify the investor base. These primarily involved tax policy in the form of tax exemption for interest income from investment in government securities and withholding tax exemption for foreign investors. Summary of Conference discussion During the Conference, participants further explored the benefits and challenges of diversifying the investor base and identified specific measures that the DMO could adopt to advance this goal. Preconditions such as minimum liquidity, benchmark instruments, and effective PD systems were considered to be essential. The retail investor segment, once developed, could represent a core segment of the investor base and provide a stable source of demand for government securities, as savvier institutional investors alter their 3

4 portfolio composition relatively more frequently. However, policymakers need to consider countryspecific issues, such as the cost of reaching retail investors building distribution networks, issuing instruments to cater to retail preferences (e.g. smaller denomination, inflation-linked, etc) and the potential impact on banks deposit base as individuals begin to direct savings towards government securities. Lack of financial literacy could be a key challenge to reach this segment. Non-resident investors could bring diversification benefits and improved liquidity, and cost savings from greater competition. At the same time, they increase a country s exposure to foreign exchange risk and global events, and bring capital flow volatility that needs to be managed. Monitoring non-resident investor characteristics was thought to be useful to inform the government s issuance strategy, market development objectives, and communication strategy. Some concrete tools at the DMO s disposal include: developing a strong investor relations program; creating new instruments to target different investor segments; incentivizing PDs to distribute securities more widely; participating in pension fund committees, pension and insurance associations, etc, to provide input on market-friendly policies and procedures; and, initiating and supporting formal structures for coordination between different government agencies. Apart from an unfavorable macro environment and bank dominance, the DMO may also face challenges from a lack of policy agenda for market development. It would therefore be critical to have input in the formulation of the debt management strategy. 4

5 Selected Reference 1. Sovereign Investor Relations Programs: 2011 Update of Key Borrowing Countries, IIF, Sep