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Corporate Bond Forum London - January 24, 2012

Need for Better Covenants and Financial Reform Effects on Liquidity Discussed at EMTA’s Corporate Bond Forum in London

Despite adding even more capacity for attendees, EMTA’s Corporate Bond Forum in London remained a standing-room-only event, as it has for several consecutive years.  ING hosted the event on Tuesday, January 24, 2012.  ING’s Head of Global EM Strategy David Spegel moderated the event’s panel discussion, which focused on the effects of regulatory reforms, bond covenants, anticipated issuance and defaults, and investor recommendations.

Providing an overview of the asset class, Warren Mar (JPMorgan) noted that his firm had recently upgraded the asset class to neutral, while anticipated heavy supply in coming months and pockets of developing risks within EM itself were working against an “overweight” recommendation.  Polina Kurdyavko (Blue Bay Asset Management) highlighted steady inflows to EM corporates for the past twelve months despite overhanging Eurozone concerns.  She acknowledged that volatility remained in the EM corporate sector, “although these periods of volatility are becoming shorter.”  Kurdyavko believed that the Eurozone crisis had already reached its nadir, and that, going forward, investors would focus increasingly on EM corporate fundamentals.

VTB’s Maxim Raskosnov noted that domestic politics are driving the Russian corporate bond markets.  Russia’s government budget was in deficit territory despite strength in oil pricing (“this won’t help ratings”), and Russian sovereign paper was becoming an increasingly less conservative credit, although not anywhere close to the peripheral European credits yet.

Spegel discussed the drop in market liquidity, attributing these to Basel III and Volcker Rule concerns, and cited EMTA bond trading statistics which help to reveal the marked decline of secondary liquidity with turnover ratios on EM bonds a third of what they were a few years ago.  Esther Chan of Aberdeen Asset Management commented that these regulations have clearly affected risk-taking and dealer inventories, and that all debt classes would suffer under financial market reforms.  “You need to think much more about time horizons on holding bonds…and you also need to be more conscious of the size of holdings in thinner markets,” she stated.

Kurdyavko argued that, relative to the high-yield and investment-grade asset classes in developed markets, liquidity in EM corporates has actually improved, noting the increased role of several dealers in 2012.  However, she acknowledged overall liquidity and resources remained an issue, with the need for more analysts and more resources for EM corporates.  She urged investors to become more involved in speaking to regulators, and believed that it would be hard to adopt a long-term view of liquidity for portfolio managers.

Mar added that liquidity was also a function of the still relative newness of the asset class, noting that although the growing number of investors in the audience each year highlighted the growth of the investor base, we still lacked the level of sponsorship enjoyed by other credit asset classes.  He noted that the level of resources dedicated to covering the asset class on both the sell- and buy-side was important to underpinning the market during times of uncertainty and crisis.

Turning to a discussion of bond covenants, Kurdyavko voiced concern that these have not improved, and attributed this to factors such as inexperienced investment bankers, increased dealer competition, the strength of the “retail bid” (which focused more on yield than structure) and lower fees (which all combined, reduces pressure for better bond structures).  “If we don’t work to change this, it will hurt our asset class...we need to be much more disciplined,” she asserted.  Chan concurred, citing a recent Banco do Brasil deal which she feared could set a poor precedent for the future.  Raskosnov added that how covenants actually fared in practice was also an issue, and referred to conflicting interpretations of clauses in defaulted BTA bonds.

Analysts’ predictions on issuance varied, with Mar at $185 billion (given the outlook for the US Dollar and low yield environment) to Kurdyavko’s $250 billion.  Raskosnov predicted light issuance in the Russian/CIS orbit due to political tensions, as well as borrowers’ sensitivity to pricing, as the local debt market has grown into a competing source of funding.  Spegel argued that a significant proportion of the $227 billion worth of EM bank loan maturities might find themselves funded in bond capital markets.  Consequently, he argued that corporate bond issuance could reach new records (possibly above $240 billion) with much more than expected coming from EM European and CIS corporates, “where European banks’ loan books are most heavily exposed.”  On expected defaults, Mar forecast a 3.9% default rate (ex-BTA recovery notes), or 2.6% for the remainder of 2012 with BTA already recorded, with Spegel a bit more positive (at below 3%) and Kurdyavko at 1.9%.

Concluding with investor recommendations, the panel had similar views on the four regions favouring Latin America over Asia followed by EM Europe and the Middle East.  Both Mar and Chan recommended the higher-quality Chinese property bonds, while the oils were favoured by Kurdyavko and Raskosnov.  Mar also suggested that investors consider Mexican homebuilders and Indonesian corporates on the heels of the sovereign upgrade.  Telecoms and utilities were among Kurdyavko’s selections.