What is an Emerging Market?
As in the case of many good questions, this one lacks a precise answer.
Be that as it may, "Emerging Market" is a term generally used to describe the group of low- and middle-income nations (previously referred to as "lesser developed countries" ("LDCs")) that, in general, are pursuing substantial political and economic reforms and a more complete integration into the global economy. It is, however, a somewhat imprecise and enigmatic term and is, perhaps, at times aspirational. Perhaps the best answer was given by one of EMTA's founding Directors, who thought that the Emerging Markets were best described as a 'state of mind'. Many international agencies consider all non-high income countries to be "Emerging Markets", stressing the potential of all nations to develop. Others include only those countries that meet certain levels of economic development and in which local equity and debt markets are operating. In general, Emerging Markets countries are characterized by an underdeveloped or developing commercial and financial infrastructure, with significant potential for economic growth and increased capital market participation by foreign investors. Countries generally considered to be Emerging Markets may possess some, but not necessarily all, of the following characteristics:
- Per capita GNP of less than U.S. $9,385 (the current World Bank definition of low- and middle-income economies);
- Recent or relatively recent economic liberalization (including, but not limited to, a reduction in the state's role in the economy, privatization of previously state-owned companies, and/or removal of foreign exchange controls and obstacles to foreign investment);
- Debt ratings below investment grade by major international ratings agencies and a recent history of defaulting on, or rescheduling of, sovereign debt;
- Recent liberalization of the political system and a move towards greater public participation in the political process; and
- Non-membership in the Organization of Economic Co-operation and Development (OECD).
Countries that are usually considered classic examples of Emerging Markets include Argentina, Brazil, India, Mexico, the Philippines, Romania and Russia, although not all of these countries possess all of the above characteristics (for example, Mexico and Russia are now rated investment grade). Countries that are sometimes considered Emerging Markets, but which possess fewer of the above characteristics, include the Czech Republic, Singapore and Turkey.
Countries which meet many of the definitions above, but which have not yet been the focus of significant foreign investment, are often referred to as "pre-Emerging Markets" or "emerging Emerging Markets". These countries include most of Africa, some Central American nations, and a number of the former Soviet republics.
Finally, it should be noted that "Emerging Markets" is a flexible term, and nations may be reclassified based upon economic events. An example of this is the Asian economic crisis which began in the summer of 1997, and which led some, at least temporarily, to re-categorize nations such as South Korea as an Emerging Market.
For EMTA's purposes, we apply a broad definition to the term "Emerging Markets" that enables EMTA to pursue projects involving countries in which the Emerging Markets trading and investment community has shown significant interest.
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How large is the marketplace for Emerging Markets debt?
The trading market for Emerging Markets instruments demonstrated substantial growth during the 1990's. When EMTA began compiling its Annual Debt Trading Volume Surveys in 1992, total reported trading volume for Emerging Markets debt instruments stood at U.S. $730 billion. In 1997, annual reported trading reached nearly U.S. $6 trillion. In the aftermath of the Asian financial crisis in mid-1997 and the Russian financial crisis the following year, trading volumes declined substantially, falling to U.S. $4.2 trillion in 1998, and to $2.2 trillion in 1999. By 2004, secondary market trading volumes had rebounded to U.S.$4.7 trillion. These figures include trading in Brady bonds, sovereign and corporate Eurobonds, local markets instruments, debt options and sovereign loans.
In addition to compiling annual reports on debt trading volumes, EMTA began compiling quarterly volume statistics in the first quarter of 1997.
For more specific information on Emerging Markets debt trading, consult EMTA's Annual and Quarterly Emerging Markets Debt Trading Volume Surveys. Click here for more information on the Survey.
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Who are the major market participants in Emerging Markets?
Before the Brady Plan, the Emerging Markets debt trading industry was composed almost exclusively of a very limited number of commercial banks that had previously lent funds to LDC countries, as well as several broker-dealers that arranged loan trades between these banks, and a few specialized investment boutiques. With the Brady Plan exchanges of Emerging Markets bank loans for more easily tradable bonds, the subsequent improvement in these economies, the issuance of substantial amounts of new Eurobond debt and the receipt of investment grade ratings by a number of Emerging Market countries, new types of investors have become active in the market. In addition to major commercial and investment banks, investors in EM debt securities include governments, insurance companies, pension funds, mutual funds, hedge funds and wealthy U.S. and foreign individuals.
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How liquid is the market for Emerging Markets instruments?
Through the exchange of billions of dollars of sovereign bank loans into Brady bonds, the Brady Plan created large pools of relatively liquid sovereign debt securities. Price spreads and commissions vary widely by type of instrument, and spreads also vary from time to time depending upon prevailing market conditions, reflecting differing levels of liquidity by instrument and over time. Although some EM debt securities trade at a substantial discount from their face value and are relatively illiquid, the most heavily traded EM debt is issued by larger countries (like Brazil, Mexico and Russia), some of which carry investment grade or near investment grade ratings, and is considered quite liquid. Historically, most EM debt securities have involved a high degree of volatility, as well as the risk that rapidly changing perceptions about credit quality of major issuing countries may have a negative effect on trading of the entire EM sector. For most assets, a "round lot" trade is considered to be U.S. $2 million face amount. Market liquidity has been adversely affected from time to time by the market's volatility and, in recent years, by the withdrawal or reduction of activity by certain market-makers from activity in the marketplace.
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How are Emerging Markets debt instruments traded and settled?
The marketplace for EM debt instruments is predominantly an over-the-counter market composed of brokers, dealers and investors located worldwide but linked informally through a network of indicative broker screens and normal telecommunications channels. Actual trading in most instruments is conducted orally, either directly between dealers or between dealers and investors, or, particularly in the case of Brady bonds and EM global bonds and Eurobonds, through inter-dealer brokers. For many years, most inter-dealer trading in the global over-the-counter market for EM debt instruments (90% or more) has been conducted through broker screens, which offer the advantages of counterparty anonymity as well as better price transparency and efficiency.
Typically, the trading of EM debt securities through these broker screens is conducted on a 'no-name give-up' basis, meaning that each dealer's bids and offers are listed anonymously, and each trade involves an offsetting purchase and sale by the broker with different dealers. In most cases, the identities of the broker's dealer counterparties are not revealed to each other (even after the trade is made), and settlement is made separately with each dealer by the broker's closing agent through Euroclear, Clearstream or DTCC. In light of the current settlement directive in the EU Central Securities Depository Regulation (“EU Directive”) for T+2 settlements, it is generally recommended that the trading and settlement of EM U.S. Dollar-denominated bonds with an XS or any prefix designated by the EU Directive settle on a T+2 business-day basis. EM U.S. Dollar-denominated bonds with a US prefix continue to settle on a T+3 business-day basis.
In most cases, the broker's sides of these offsetting trades are assumed as principal, and cleared on a fully disclosed basis, by a private clearing entity, which typically assumes responsibility for each trade either late in the trading day or on the following morning.
A small group of major dealers provide much of the market's liquidity in many instruments and are, therefore, often referred to informally as "market-makers", although they are not legally required to do so. Oral trades, which are considered binding, are typically confirmed by fax.
In general, the trading and settlement of EM debt securities occurs in accordance with customary international securities procedures, although a portion of such trading and settlement is subject to domestic U.S. procedures for the U.S. institutional market. Because EM global bonds and Eurobonds are a separately identifiable asset class with individual asset characteristics and market structure, EMTA has developed numerous Market Practices for their trading and settlement. For further information regarding EMTA Market Practices, click here.
Until recently, purchases and sales of many EM debt securities by major participants in the inter-dealer market were generally cleared and settled through the Emerging Markets Clearing Corporation (EMCC), a clearing organization operated as an affiliate within the National Securities Clearing Corporation (NSCC) family of clearing organizations. EMCC, which was sponsored by EMTA, commenced operations in April 1998 and supported the further development of screen-based trading in the inter-dealer market by reducing counterparty risk and improving certain operating efficiencies.
Following an extensive review by EMTA's Industry Steering Group (composed of representatives of most of the major EM dealers), LCH.Clearnet was selected to provide a service similar to that provided by EMCC with a start date of Fall 2005.
Sovereign loan trading generally is conducted in accordance with EMTA Market Practices and standard documentation. The settlement of loan trades is more complex and time-consuming than for Brady bonds or Eurobonds, largely because of the absence of centralized clearing and settlement mechanisms for loans. Accordingly, the settlement of loan trades (which normally occurs on either a T+15 business day basis or a twice monthly "batched" basis) is handled individually by dealers and other market participants. The settlement of loan assignments is normally followed by the registration of such assignments with the applicable agent or servicing bank. If the loan trade is structured as the sale of a participation, no such registration is required. Market Practice 112 concerning the 2005 batch settlement of Emerging Markets Loans is available in our MEMBERS ONLY section.
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What is a Brady Bond?
The Brady Plan, as originally announced by former U.S. Treasury Secretary Nicholas F. Brady, contemplated the exchange of commercial bank loans for collateralized debt securities as part of an internationally supported sovereign debt restructuring. Many so-called “Brady bonds” conform to these original characteristics. Other debt instruments, also known generically as “Brady bonds”, were issued as part of later sovereign debt restructurings which did not adhere strictly to the originally envisioned model. It is important to understand that it was U.S. policy to encourage a somewhat adhoc evolution of sovereign debt restructurings so that they included an increasingly diversified “menu of options” that would make such restructurings attractive to the commercial banking community.
Accordingly, the terms “Brady Plan” and “Brady bond” are without any precise legal meaning and, in EMTA's view, the term “Brady bond” properly refers simply to debt securities issued as part of a Brady Plan restructuring or any similar country debt restructuring or financing plan. As commonly used, the term “Brady bond” includes debt securities that may or may not be collateralized, provided that they were issued either in exchange for commercial bank loans (or accrued interest thereon) or (in the case of some New Money Bonds) as one of the menu options made available as part of a sovereign debtor’s restructuring or refinancing of its external indebtedness.
Generally speaking, the term “Brady bonds” does not include debt securities offered by a sovereign debtor to foreign investors through normal underwriting syndication channels at or near par. In some cases, however, the term has been used to include sovereign debt securities issued in exchange for bank loans or other debt instruments, not as part of a general restructuring of a sovereign’s external indebtedness, but rather as part of a market-oriented transaction designed to refinance a portion of such outstanding indebtedness; in these cases, the term has probably been used because such debt securities have characteristics (such as collateral or method of issuance and distribution) similar to the more conventional “Brady bonds”.
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What do Local Markets and Local Markets instruments mean?
"Local Market" generally refers to the domestic, or internal, market for a country. "Local markets instruments" are instruments generally issued into a domestic market and purchased by local and foreign investors. Local markets instruments are denominated most often in the local currency and include domestic treasuries, bank certificates of deposit and bonds, as well as other forms of indebtedness. There is substantial trading activity in local markets instruments, which accounted for U.S. $2 trillion in turnover in 2004, or 45% of all Emerging Markets debt trading reported to EMTA.
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