OECD Business and Finance SCOREBOARD

Transcription

1 OECD Business and Finance SCOREBOARD 2016

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3 OECD Business and Finance Scoreboard 2016

4 This work is published under the responsibility of the Secretary-General of the OECD. The opinions expressed and arguments employed herein do not necessarily reflect the official views of OECD member countries. This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. OECD 2016

5 ABOUT THE OECD BUSINESS AND FINANCE SCOREBOARD The OECD Business and Finance Scoreboard accompanies the OECD Business and Finance Outlook by providing a commented overview of selected indicators and data related to corporate performance, banking, capital markets, pensions and investments. While some of the indicators and developments are subject to in-depth analysis in the Outlook, others appear only in the Scoreboard, giving the reader complementary information and additional opportunities for analysis. The Scoreboard makes use of data that is collected directly by the OECD as well as calculations that are based on information available in different external databases. A detailed description of the methodology for data collection and analysis is provided in the annex. The indicators and data that feature in this edition of the Scoreboard, primarily reflect the focus of the 2015 and 2016 OECD Business and Finance Outlooks. Going forward, the objective is to establish a useful balance between relevant standardised indicators to be tracked over time and quantitative information that primarily is tailored to support the policy themes that will be addressed in subsequent editions of the Business and Finance Outlook. 3

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7 Table of contents About the OECD Business and Finance Scoreboard... 3 Acronyms and abbreviations... 8 Editorial... 9 Global trends in productivity Declining investment opportunities Greater capital expenditure in emerging economies A global surge in corporate bond issues The maturity divergence An increase in emerging market use of public equity markets A decline in initial public offerings by small companies Public equity markets remain an important source of continuous financing New industrial sectors using corporate bonds Sectoral trends in the use of public equity markets A decline in overall corporate bond ratings The decline in corporate bond covenant protection Distance-to-default has fallen A measure of the value of implicit guarantees for the debt of large banks Bank beta indicator Pension funds investments fell slightly in 2015 relatively to The low returns in 2015 mostly explain the fall in pension funds investments Negative returns in stock markets may be behind the weak performance of pension funds investments in Global trends in FDI flows Equity capital FDI flows surged in Capital passing through Special Purpose Entities (SPEs) dropped significantly in 2014 and Pace of liberalising regulatory restrictions on FDI has slowed in recent years Shifting view of the origin of FDI: Investors hold investments indirectly through Luxembourg and the Netherlands Global trends in mergers and acquisitions Openness of banking systems Saving-investment correlation ANNEX: Methodology for data collection and analysis

8 Figures Figure 1. Productivity measures for listed non-financial companies, Figure 2. Return on equity, cost of equity and cost of capital, Figure 3. Listed non-financial company corporate finance data, Figure 4. Outstanding stock of non-financial corporate bonds, Figure 5. Average maturities for corporate bonds issued by non-financial companies, Figure 6. Initial public offerings (IPOs), Figure 7. Small non-financial company IPOs in advanced economies, Figure 8. Secondary public offerings in advanced and emerging economies, Figure 9. Corporate bond issuance by companies in energy, industrials and materials sectors, Figure 10. Distribution of public equity financing among different sectors, Figure 11. Rating quality and new supply of corporate bonds, Figure 12. Covenant protection index for corporate bonds issued in the United States, Figure 13. Distance-to-default (DTD) of large listed banks, Figure 14. Credit rating uplifts for the debt of large banks, Figure 15. Bank beta indicator for large listed banks, Figure 16. Pension funds' real net investment rate of return in selected OECD countries, Figure 17. Pension fund asset allocation in selected asset classes in selected OECD countries, Figure 18. Foreign direct investment inflows by region, Figure 19. Foreign direct investment by instruments, Figure 20. Total FDI outflows from selected OECD countries with resident SPEs, Figure 21. Total FDI inflows to selected OECD countries with resident SPEs, Figure 22. OECD FDI Regulatory Restrictiveness Index, Figure 23. Inward FDI positions by major ultimate partners versus immediate partners Figure 24. Domestic and Cross-Border M&A deals, Figure 25. Deviations from covered interest parity (CIP) on domestic forward (DF) and nondeliverable forward (NDF) markets, Figure 26. Saving-investment correlation,

9 Tables Table 1. Average value added and net sales data for listed companies, Table 2. Average return on equity, cost of capital and debt data for listed companies, Table 3. Key financial data for non-financial listed companies, Table 4. Outstanding stock of corporate bonds, Table 5. Average maturities for corporate bonds, Table 6. Initial public offerings, Table 7. Small non-financial company IPOs in advanced and emerging economies Table 8. Secondary public offerings, Table 9. Distribution of corporate bond issuance among different sectors, Table 10. Distribution of public equity financing among different sectors, Table 11. Distribution of corporate bond issuance among rating categories, Table 12. Frequency of different types of corporate bond covenants, Table 13. Average distance-to-default (DTD) of large listed banks, Table 14. Average beta calculated using MSCI regional equity indices for large listed banks, Table 15. Average beta calculated using MSCI global equity index for large listed banks, Table 16. Total investment of pension funds and all retirement vehicles, Table 17. Pension funds' real net rate of investment returns in selected OECD countries, Table 18. FDI inflows by selected regions, Table 19. FDI outflows by selected regions, Table 20. FDI inflows and outflows by instrument for selected regions, Table 21. FDI outflows for countries with SPEs, Table 22. FDI inflows for countries with SPEs, Table 23. OECD FDI Regulatory Restrictiveness Index, OECD countries per sector, Table 24. OECD FDI Regulatory Restrictiveness Index, Non-OECD countries per sector, Table 25. Inward FDI positions by Immediate (IMD) versus Ultimate (ULT) partner country Table 26. Inward FDI positions by Immediate (IMD) versus Ultimate (ULT) partner country for selected OECD countries Table 27. Domestic and Cross-Border M&A deals, Table 28. Deviations from covered interest parity (CIP) on domestic forward (DF) markets, Table 29. Deviations from covered interest parity (CIP) on non-deliverable forward (NDF) markets, Table 30. Saving-investment correlation by region,

10 Acronyms and abbreviations BRICS BRIICS CAPEX CIP COD COE COK DF DTD EBITDA EME FDI GARCH GICS IG IPO M&A MSCI NDF OECD R&D REIT ROE SPEs SPO Brazil, Russia, India, China, and South Africa Brazil, Russia, India, Indonesia, China, and South Africa company capital expenditure covered interest parity cost of debt cost of equity cost of capital domestic forward distance-to-default earnings before interest, taxes, depreciation and amortisation emerging market economy foreign direct investment Generalized Auto Regressive Conditional Heteroskedasticity Global Industry Classification Standard investment grade initial public offering mergers and acquisitions Morgan Stanley Composite Index non-deliverable forward Organisation for Economic Co-operation and Development research and development real estate investment trusts return on equity special purpose entities secondary public offering (follow-on offering) 8

11 Editorial Despite the fact that the interest rates have been kept at record lows since the financial crisis, the world economy is still beset with major headwinds. As a consequence, there is little doubt that the journey towards economic recovery increasingly has to rely on structural adjustments. Of particular importance is the ability of the corporate sector to adjust to the reversal of the commodity supercycle through a combination of orderly creative destruction and corporate strategies that promote productive investments. From a policy perspective, these challenges call for a better understanding of the relationships between business behaviour and macroeconomic conditions. Notably, how monetary regimes and regulatory reforms influence the decisions of both investors and corporations to focus on long term value creation. This Scoreboard provides indicators that will help policy makers to monitor changes in business behaviour that influence firm level performance and productivity. This includes indicators of how they use productivity enhancing strategies such as research and development, cash flow management and corporate restructuring. It also contains indicators of how, and to what extent, corporations use market based finance, such as equity and corporate bonds. One important indicator of how effectively corporations use the capital that they have at their disposal is the return-on-equity. Building on a global sample of about large listed companies, the Scoreboard shows that return-on-equity minus the cost-of-equity has fallen. In the last couple of years it has even been negative in emerging markets, which indicates the existence of excess capacity and the need for structural adjustments. Access to equity capital is essential for long term investments, such as innovation and product development; particularly for smaller growth companies. However, the amount of new equity capital that corporations raised through initial public offerings (IPOs) declined in And while the number of IPOs by growth companies in advanced economies slightly increased, the total amount of new equity capital that they raised actually declined and remains at a low level. Considering the consistently low level of growth company IPOs in the last decade, more can probably be done to increase their access to public equity markets. Bonds have become an increasingly important source of finance for corporations worldwide and the stock of outstanding corporate bonds continued to increase in At the same time, the overall rating quality of corporate bonds remains considerably lower than before the 2008 financial crisis. This is mainly an effect of the high share of non-investment grade bonds and B-grade bonds being issued. The covenant protection index for non-investment grade corporate bonds also remains at a low level, indicating that investors in their search for yield are still willing to forego certain governance rights. 9

12 Analysis of firm level data in the OECD Business and Finance Outlook suggests that some companies with high productivity growth may use mergers and acquisitions to rationalise their businesses in a more competitive environment. Globally, the volume of corporate mergers and acquisitions grew by almost one third in The surge was fuelled mainly by domestic mergers and acquisitions in advanced economies, who account for almost three quarters of the value of all mergers and acquisitions. To develop their business, corporations may also take advantage of entering and expanding in overseas markets. While the global flow of foreign direct investments has remained fairly stable since the financial crisis, 2015 saw an increase of about 25%. This increase was fuelled mainly by an increased inflow to the European Union and the United States, while the People s Republic of China experienced a small decrease in inward foreign direct investments. The OECD Business and Finance Outlook 2016 underlines the need to address the links between the regulatory framework, the macroeconomic environment and business behaviour. By innovative use of micro level data, this Scoreboard contributes to this effort and the shaping of coherent policies that will support productivity, sustainable growth and better lives for all. Adrian Blundell-Wignall Special Advisor to the Secretary-General on Financial Markets Director for Financial and Enterprise Affairs, OECD 10

13 Global trends in productivity In recent years, productivity measured both as company value-added (wages plus EBITDA) per employee and net sales per employee have declined. While net sales per employee in emerging economies, as a result their increased participation in global value chains, has caught up with levels in advanced economies, it has not allowed for a similar catch up with respect to productivity measured as value added per employee. Figure 1. Productivity measures for listed non-financial companies, Value added Net sales (RHS) USD bln /1000 employ ees Advanced economies USD bln /1000 employ ees Emerging economies USD bln /1000 employ ees USD bln /1000 employ ees Table 1. Average value added and net sales data for listed companies, Value added per capita United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Net sales per capita United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Note: All data are expressed in US dollar billion per one thousand employees. Europe refers to the European Union, Norway and Switzerland. BRIICS refers to Brazil, Russia, India, Indonesia, China and South Africa. Other Asia refers to Hong Kong (China), Singapore, Korea and Chinese Taipei. Value added: sum of personnel expenses and EBITDA (i.e. income before interest, taxes, depreciation and amortisation). Net sales: total operating revenues less various adjustments to gross sales. Source: OECD calculations, Bloomberg. See Annex for details. 11

14 Declining investment opportunities In emerging economies both the return on equity (ROE) minus the cost-of-equity and the ROE minus cost-of-capital are today negative. This is consistent with other evidence that these economies exhibit excess capacity in important sectors resulting from overinvestment. With a decrease in investment opportunities, dividends and buybacks have been rising in advanced economies since the 2008 financial crisis. Debt financing is still greater in advanced economies but emerging economies are catching up. Figure 2. Return on equity, cost of equity and cost of capital, Advanced economies Emerging economies % Dividend & Buybacks ROE - COK ROE - COE % 10 Dividend & Buybacks ROE - COK ROE - COE Debt-to-equity ratio Advanced economies Emerging economies Ratio Source: Bloomberg, OECD calculations. See Annex for details. 12

15 Table 2. Average return on equity, cost of capital and debt data for listed companies, Debt to equity ratio United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies ROE minus COE (%) United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies ROE minus COK (%) United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Dividend & Buybacks (% of net sales) United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Note: Europe refers to the European Union, Norway and Switzerland. BRIICS refers to Brazil, Russia, India, Indonesia, China and South Africa. Other Asia refers to Hong Kong (China), Singapore, Korea and Chinese Taipei. Dividend and buybacks ratios are expressed in percent of net sales. Debt to capital ratio: ratio of debt to the sum of debt plus equity. ROE (return on equity): ratio of net income to common equity. COE (cost of equity): sum of dividend and buyback yield and underlying trend in EPS growth. COK (cost of capital): weighted average (by the share of equity and debt in total assets, respectively) sum of cost of equity and cost of debt. Source: Bloomberg, OECD calculations. See Annex for details. 13

16 Greater capital expenditure in emerging economies Companies in emerging economies invest much more as a percentage of net sales than companies in advanced economies. However, advanced economies are benefitting from efficacy of three corporate strategies that boost their productivity: higher research and development; higher free cash flow, and; more mergers and acquisition activities to rationalise business models. Figure 3. Listed non-financial company corporate finance data, Advanced economies Free cashflow R&D expenditure M&A deal value Capital expenditure (RHS) % of net sales % of net sales % of net sales Emerging economies % of net sales Source: Bloomberg, OECD calculations. See Annex for details. 14

17 Table 3. Key financial data for non-financial listed companies, Capital expenditure United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Free cash flow United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies R&D expenditure United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies M&A deal value United States Europe Japan Australia & New Zealand BRIICS Other Asia Other EMEs Advanced Economies Emerging Economies Note: All data are expressed in percent of net sales. Europe refers to the European Union, Norway and Switzerland. BRIICS refers to Brazil, Russia, India, Indonesia, China and South Africa. Other Asia refers to Hong Kong (China), Singapore, Korea and Chinese Taipei. Capital expenditure: amount the company spent on purchases of tangible fixed assets. Free cash flow: operating cash flow minus capital expenditures. R&D expenditure: operating expense related to the research and development of a company's products or services. M&A deal value: declared amount effectively paid by the acquirer for the target. Source: Bloomberg, OECD calculations. See Annex for details. 15

18 A global surge in corporate bond issues Since 2008, corporate bonds have become an increasingly important source of financing also for nonfinancial companies. Two main factors seem to have contributed to this development: first the decrease in bank lending to non-financial companies (so-called deleveraging), and; second, the historically low levels of bond interest rates. From being a negligible source of external finance a decade ago, the outstanding stock of corporate bonds has reached significant levels also in emerging economies. Figure 4. Outstanding stock of non-financial corporate bonds, Table 4. Outstanding stock of corporate bonds, World Non-financial Financial Investment grade Non-investment grade Advanced economies Non-financial Financial Investment grade Non-investment grade Emerging markets Non-financial Financial Investment grade Non-investment grade United States Non-financial Financial Investment grade Non-investment grade Europe Non-financial Financial Investment grade Non-investment grade OECD Non-financial Financial Investment grade Non-investment grade Note: All data are expressed in US dollar trillion. Source: Thomson Reuters, Bloomberg, OECD calculations. See Annex for details. 16

19 The maturity divergence The average maturities for investment grade bonds issued by non-financial companies in the United States have always been longer than for bonds issued by companies in the rest of the world. However, the total difference in average maturity has increased quite considerably since the financial crisis. Figure 5. Average maturities for corporate bonds issued by non-financial companies, Table 5. Average maturities for corporate bonds, World Non-financial Financial Investment grade Non-investment grade Advanced economies Non-financial Financial Investment grade Non-investment grade Emerging markets Non-financial Financial Investment grade Non-investment grade United States Non-financial Financial Investment grade Non-investment grade Europe Non-financial Financial Investment grade Non-investment grade OECD Non-financial Financial Investment grade Non-investment grade Note: Average maturities are expressed in number of years. Source: Thomson Reuters, OECD calculations. See Annex for details. 17

20 An increase in emerging market use of public equity markets Companies tap public equity markets for funding for the first time by making an initial public offering (IPO). During the early 2000s, global IPO activity was dominated by companies from advanced economies. However, in the last ten years, companies from emerging markets account for almost half of the money raised through IPOs. Figure 6. Initial public offerings (IPOs), Table 6. Initial public offerings, World Non-financial Financial Advanced economies Non-financial Financial Emerging markets Non-financial Financial United States Non-financial Financial Europe Non-financial Financial OECD Non-financial Financial Note: All data are expressed in 2015 US dollar billion. Source: Thomson Reuters, OECD calculations. See Annex for details. 18

21 A decline in initial public offerings by small companies The last decade has seen a fairly marked decline in the extent to which small and medium-sized growth companies access public equity markets for external funding. This trend is particularly marked in the United States and in Europe. Today, companies in advanced economies that actually use public equity markets for the first time tend to be larger at the time of the IPO. Figure 7. Small non-financial company IPOs in advanced economies, Table 7. Small non-financial company IPOs in advanced and emerging economies Global Advanced economies Emerging economies Total value of IPOs with size less than USD 100 M (2015 USD, million) 173, , ,569 62,083 50,258 80,167 Share of all IPOs 14.5% 13.7% 10.3% 6.0% 4.2% 7.7% Number of IPOs with size less than USD 100 M (%) 7,765 4,926 5,881 2,699 1,884 2,227 Share of all IPOs 78.1% 70.8% 59.1% 38.8% 18.9% 32.0% Source: Thomson Reuters, OECD calculations. See Annex for details. 19

22 Public equity markets remain an important source of continuous financing The role of public equity markets in providing a company with new equity capital is not limited to the time of the initial public offering (IPO). They also provide an opportunity for companies that are already listed to raise additional capital through a secondary public offering (SPO) or follow-on issue. In fact, every year since 2000, the global amount of money raised through SPOs exceeded the amount of money raised through IPOs. Record SPO levels were reached in the two years following the 2008 financial crisis. Figure 8. Secondary public offerings in advanced and emerging economies, Table 8. Secondary public offerings, World Non-financial Financial Advanced economies Non-financial Financial Emerging markets Non-financial Financial United States Non-financial Financial Europe Non-financial Financial OECD Non-financial Financial Note: All data are expressed in 2015 US dollar billion. Source: Thomson Reuters, OECD calculations. See Annex for details. 20

23 New industrial sectors using corporate bonds The single most important sector with respect to the use of corporate bonds is the financial services sector. However, the relative importance of the financial services sector has declined by one fifth during the post-crisis period and was mainly replaced by the energy, industrials and materials sectors. This shift was also the result of a large absolute increase in the amount of money raised by these supercycle sectors. Figure 9. Corporate bond issuance by companies in energy, industrials and materials sectors, Table 9. Distribution of corporate bond issuance among different sectors, Consumer Products and Services Volume Share 1% 2% 1% 1% 2% 2% 2% 1% 1% 2% 2% 2% 2% 2% 2% 2% Consumer Staples Volume Share 3% 3% 3% 3% 1% 1% 1% 2% 3% 4% 3% 3% 3% 4% 3% 4% Energy Volume Share 8% 9% 10% 8% 6% 5% 6% 8% 11% 17% 12% 12% 13% 13% 12% 11% Financials Volume 1,346 1,308 1,286 1,881 2,130 2,165 2,699 2,574 1,927 1,539 1,829 1,744 1,867 1,678 1,987 1,753 Share 65% 55% 64% 68% 75% 76% 74% 72% 68% 48% 58% 56% 52% 48% 55% 52% Healthcare Volume Share 0% 2% 1% 1% 1% 1% 1% 2% 1% 4% 2% 3% 3% 3% 4% 6% High Technology Volume Share 2% 2% 1% 1% 1% 1% 1% 1% 2% 2% 2% 3% 2% 3% 3% 5% Industrials Volume Share 6% 7% 5% 6% 4% 4% 4% 4% 4% 8% 7% 7% 7% 9% 6% 7% Materials Volume Share 3% 3% 4% 3% 3% 2% 3% 2% 3% 5% 5% 5% 6% 5% 4% 3% Media and Entertainment Volume Share 2% 3% 2% 3% 2% 2% 2% 1% 1% 3% 3% 2% 3% 2% 3% 3% Real Estate Volume Share 1% 1% 1% 1% 1% 1% 2% 1% 1% 1% 2% 2% 2% 3% 3% 3% Retail Volume Share 2% 2% 2% 1% 1% 1% 1% 2% 2% 2% 2% 2% 2% 2% 2% 2% Telecommunications Volume Share 9% 10% 4% 3% 3% 3% 3% 2% 3% 5% 3% 4% 3% 6% 4% 3% Note: All data are expressed in 2015 US dollar billion. Source: Thomson Reuters, OECD calculations. See Annex for details. 21

24 Sectoral trends in the use of public equity markets At the time of the financial crisis, companies in the financial services sector significantly increased their use of public equity markets for external financing. This strengthening of financial companies balance sheets was mainly done through secondary public offerings (SPO). The use of public equity markets by the telecommunications industry before the crisis has declined to very low levels. Figure 10. Distribution of public equity financing among different sectors, Table 10. Distribution of public equity financing among different sectors, Consumer Products and Services Volume Share 4% 4% 4% 3% 3% 4% 5% 3% 1% 2% 2% 3% 2% 5% 5% 5% Consumer Staples Volume Share 2% 5% 4% 2% 4% 4% 4% 4% 6% 4% 4% 4% 4% 6% 4% 3% Energy Volume Share 7% 11% 12% 12% 16% 15% 13% 14% 9% 9% 19% 14% 13% 12% 12% 9% Financials Volume Share 11% 19% 22% 28% 18% 25% 28% 25% 51% 46% 35% 31% 33% 23% 22% 25% Healthcare Volume Share 7% 8% 5% 4% 5% 5% 4% 5% 2% 2% 3% 5% 4% 6% 7% 10% High Technology Volume Share 28% 12% 10% 11% 11% 10% 8% 7% 2% 5% 5% 7% 8% 9% 12% 9% Industrials Volume Share 6% 9% 11% 10% 12% 12% 11% 14% 10% 9% 13% 10% 13% 14% 13% 12% Materials Volume Share 2% 5% 7% 8% 8% 7% 11% 14% 11% 12% 10% 16% 9% 9% 8% 8% Media and Entertainment Volume Share 6% 5% 7% 4% 6% 4% 4% 3% 1% 3% 2% 3% 3% 5% 5% 4% Real Estate Volume Share 1% 1% 1% 1% 2% 3% 5% 7% 2% 5% 2% 2% 2% 4% 5% 4% Retail Volume Share 2% 4% 5% 4% 4% 2% 4% 2% 1% 2% 2% 4% 4% 5% 5% 5% Telecommunications Volume Share 25% 17% 11% 12% 11% 9% 5% 3% 3% 2% 2% 1% 3% 3% 3% 4% Note: All data are expressed in 2015 US dollar billion. Source: Thomson Reuters, OECD calculations. See Annex for details. 22

25 A decline in overall corporate bond ratings Since the financial crisis, corporate bond markets have experienced a significant decrease in overall corporate bond rating quality. This is the result of an increased share of non-investment grade bonds and B-grade bonds being issued. As a consequence, the weighted bond rating index, which is constructed by assigning the value 1 to the lowest credit quality rating and 21 to the highest credit quality rating, shows an almost 20% decline in rating quality since Figure 11. Rating quality and new supply of corporate bonds, Table 11. Distribution of corporate bond issuance among rating categories, as a percentage of total, A-grade investment 86% 78% 80% 78% 80% 83% 81% 82% 88% 71% 65% 67% 58% 53% 55% 58% B-grade investment 9% 16% 14% 13% 11% 10% 11% 10% 10% 19% 18% 17% 25% 27% 26% 27% B-grade non-investment 4% 6% 5% 8% 8% 6% 7% 7% 3% 10% 16% 14% 16% 18% 18% 14% C-grade non-investment 0% 0% 0% 0% 1% 1% 1% 1% 0% 0% 1% 1% 1% 2% 1% 1% Note: There are eleven non-investment grade categories: five from C, C to CCC+; and six from B, B- to BB+. There are ten investment grade categories: three from B, BBB- to BBB+; and seven from A, A- to AAA. The index is weighted as one for C, two for CC and rising to twenty one for AAA. A fall in the index indicates declining quality. Source: Thomson Reuters, Bloomberg, OECD calculations. See Annex for details. 23

26 The decline in corporate bond covenant protection The increase in non-investment grade bond issues has been accompanied by a shift in the characteristics of corporate bond indentures, which is the contract containing the main features of the bond, including any restrictive conditions (the covenants). The covenant protection index, which tracks the frequency of different covenants used in the United States, has declined significantly for non-investment grade bonds since While a minor improvement can be noted in the last couple of years, the overall decline and the accompanying decline in rating quality, suggest that bond investors in their search for yield have been willing to trade governance rights and protection for higher expected returns. Figure 12. Covenant protection index for corporate bonds issued in the United States, Note: The 34 covenant variables in the dataset are matched to the 15 covenant types. If a bond had at least one covenant that belongs to a certain covenant type, it was considered to have that covenant type. For each covenant type, a binary variable was generated, which is equal to 1 if the covenant type is available in the bond indenture. The binary variables are then summed, divided by 15 to create an index that ranges from 0 to 1, with the ratio 1 (0) denoting the highest (lowest) possible protection for bondholders. Data from the binary variables frequency in selected sub-categories are shown in Table 12 below. Source: OECD, Corporate Bonds, Bondholders and Corporate Governance, OECD Corporate Governance Working Papers, No. 16, updated with 2014 data. 24

27 Restrictions on Investment Activities and Asset Sales Event-driven Covenants Restrictions on Financing Activities Restrictions on Payouts Table 12. Frequency of different types of corporate bond covenants, Number of observations Non-IG IG Dividend Payment Restrictions Non-IG 76% 82% 86% 78% 82% 84% 65% 58% 59% 45% 50% 54% 34% 41% 42% IG 2% 3% 1% 3% 6% 6% 1% 2% 1% 2% 2% 1% 1% 1% 0% Share Repurchase Restrictions Non-IG 88% 88% 91% 86% 84% 86% 67% 61% 57% 49% 53% 63% 43% 54% 46% IG 6% 4% 4% 3% 2% 1% 0% 1% 1% 1% 2% 1% 0% 0% 1% Funded Debt Restrictions Non-IG 0% 0% 0% 0% 0% 0% 0% 1% 1% 0% 0% 0% 0% 0% 0% IG 2% 1% 1% 1% 1% 1% 0% 2% 1% 0% 0% 1% 1% 1% 0% Subordinated Debt Restrictions Non-IG 11% 28% 36% 7% 0% 1% 2% 2% 1% 0% 0% 0% 0% 0% 0% IG 0% 0% 0% 0% 0% 1% 1% 0% 1% 1% 0% 1% 2% 0% 1% Senior Debt Restrictions Non-IG 2% 1% 0% 2% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% IG 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Secured Debt Restrictions Non-IG 78% 71% 74% 76% 72% 88% 78% 66% 68% 54% 53% 57% 45% 62% 57% IG 60% 74% 67% 66% 55% 61% 60% 60% 69% 57% 50% 51% 54% 52% 53% Leverage Restrictions Non-IG 91% 91% 93% 89% 89% 88% 72% 64% 61% 54% 56% 65% 48% 60% 57% IG 14% 13% 12% 12% 15% 17% 15% 12% 8% 6% 11% 11% 11% 10% 17% Sale & Lease Back Non-IG 49% 41% 45% 49% 43% 44% 47% 27% 18% 29% 29% 23% 22% 26% 30% IG 30% 36% 35% 37% 28% 31% 35% 41% 48% 44% 41% 43% 46% 43% 40% Stock Issue Restrictions Non-IG 62% 67% 66% 63% 70% 70% 52% 49% 48% 31% 31% 40% 23% 28% 26% IG 4% 4% 6% 8% 12% 10% 7% 5% 3% 1% 2% 0% 0% 0% 1% Rating & NW Triggers Non-IG 1% 5% 5% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% IG 1% 2% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 1% Cross Default Provisions Non-IG 94% 96% 95% 75% 92% 90% 73% 70% 74% 64% 67% 73% 63% 75% 74% IG 49% 48% 40% 38% 52% 64% 59% 59% 58% 49% 74% 89% 89% 94% 89% Poison Put Non-IG 92% 89% 93% 86% 88% 88% 81% 92% 82% 89% 90% 91% 91% 89% 86% IG 5% 5% 2% 2% 2% 3% 8% 39% 39% 42% 45% 38% 42% 35% 43% Asset Sale Restrictions Non-IG 95% 99% 98% 99% 98% 98% 92% 78% 75% 67% 67% 77% 65% 75% 75% IG 87% 92% 96% 93% 88% 90% 87% 83% 84% 59% 68% 81% 87% 89% 89% Investment Policy Restrictions Non-IG 9% 7% 4% 2% 2% 2% 5% 1% 4% 21% 10% 0% 1% 1% 2% IG 2% 2% 1% 1% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% Merger Restrictions Non-IG 92% 98% 97% 97% 97% 97% 92% 78% 75% 66% 67% 75% 63% 75% 75% IG 86% 91% 95% 93% 88% 89% 88% 83% 84% 59% 66% 81% 87% 89% 88% Source: OECD, Corporate Bonds, Bondholders and Corporate Governance, OECD Corporate Governance Working Papers, No. 16, updated with 2014 data. 25

28 Distance-to-default has fallen Bank default risk is measured by the distance-to-default (DTD). A bank defaults when DTD moves to 0 and below. Recently the average DTD of banks has fallen in all regions. In Asia, the DTD is back to levels last seen in In Latin America, the DTD is at levels last seen in US banks appear to be the strongest at this point. Nevertheless the situation bears watching closely. Figure 13. Distance-to-default (DTD) of large listed banks, United States Europe Asia Latin America 8 Std. dev Table 13. Average distance-to-default (DTD) of large listed banks, United States All Large Banks G-SIBs Other Large Banks Europe Asia Latin America United States 26 Europe Asia United States Europe Asia Latin America Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Mar Notes: Europe refers to the European Union, Norway and Switzerland. Banks included in the sample are listed in Bloomberg regional banking indices. The horizontal 3-standard-deviation line represents a minimal level of safety based on calibration from previous crises. The distance-to-default (DTD) is a measure that uses a combination of bank reported data, and market information to calculate the number of standard deviations a bank is from the default point, where the market values of assets equals the book value of debt. The formula is derived from the option pricing model of Black and Scholes (1973). Source: Thomson Reuters, Bloomberg, OECD calculations. See Annex for details.