The BIS Quarterly Review released today
is divided into two parts. The first presents an overview of recent
developments in financial markets, before turning in more detail to financing
flows in banking and debt securities markets, and activity in derivatives
markets. The second part presents two special feature articles: one on
securitisation in Asia and the Pacific, and another on the development of
domestic bond markets in Latin America.
Retreat from risky assets
Yields on government bonds rose substantially up to the middle of May,
reflecting expectations of robust growth as well as concerns about higher
inflation. Initially, the rise in yields had little effect on the prices of
risky assets or on investor risk appetite as strong fundamentals were thought
to outweigh the impact of higher discount rates. Equity and commodity markets
continued to rally into May, and spreads on lower-rated corporate and emerging
market debt tightened further. The dollar depreciated significantly against
other major currencies in late April and early May, with little apparent effect
on other markets.
Concerns about the pace of recent gains in a broad range of markets culminated
in an abrupt end to the rally in mid-May. Markets around the world fell.
Emerging equity markets were the hardest hit, but losses were also recorded in
other markets. Rather than a reassessment of fundamentals, the drop in the
price of risky assets seems to have reflected primarily a higher risk aversion
among market participants. This resulted in a reallocation of portfolios in
favour of highly rated instruments such as government bonds.
The international debt securities market
Issuance of bonds and notes in international debt securities markets increased
by 24% on a gross basis in the first quarter of 2006, to around $1.2 trillion,
and by 9% on a net basis, to $622 billion. These levels represented historical
peaks, suggesting ready access for borrowers to international credit markets
and favourable financing conditions. Important contributors to the growth in
gross issuance during the first quarter were, from a geographical point of
view, US entities and, from a sectoral perspective, corporate issuers. US
borrowers also significantly increased their funding in net terms, while euro
area net borrowing grew at a more modest pace. Net issuance by Japanese
entities increased markedly to a level that exceeded the total amount issued
during the previous six quarters.
Last year's record-breaking issuance of international bonds and notes by
emerging market borrowers was followed by continued robust activity in the
first quarter of 2006, as borrowers took advantage of persistently narrowing
spreads. Gross emerging market borrowing rose by 19% compared to the last
quarter of 2005, reaching a new high of just below $60 billion, while net
borrowing jumped by 33% to $42 billion also a record level. While
improving fundamentals have underpinned this strength for some time, the recent
brisk pace seems also to have been fuelled to some extent by the search for
yield among international investors.
Derivatives markets
The pace of trading on the international derivatives exchanges quickened in the
first quarter of 2006. Combined turnover measured in notional amounts of
interest rate, equity index and currency contracts increased by one quarter to
$429 trillion between January and March 2006. The growth in turnover was
particularly strong in interest rate products, as changing perceptions about
the future course of monetary policy in the United States and Japan lifted
activity in money market contracts in the US dollar and yen. Due to valuation
effects from higher equity prices, turnover in derivatives on stock indices
reached a record $43 trillion in the first quarter, up 11% from the previous
three months. Volume increased sharply in derivatives on energy and
non-precious metals, and was stable at a high level in contracts on precious
metals.
Growth in the market for credit default swaps (CDSs) remained strong in the
second half of 2005. The notional amount of CDSs outstanding increased by one
third between end-June and end-December 2005 to $14 trillion. The rapid growth
in these instruments has exposed several weaknesses in the market, such as
occasional shortages of deliverable debt and backlogs in trade confirmations,
though progress is being made in addressing these issues. A new and improved
breakdown of the CDS statistics by counterparty indicates that the CDS market
is largely an interbank market, and that purchases of CDSs by insurance
companies to take on credit risk are limited.
The international banking market
BIS reporting banks' cross-border claims continued to expand in the fourth
quarter of 2005. The bulk of this expansion was driven by greater intra-euro
area lending, although new credit to borrowers in the United States and Japan
also contributed. Yen-denominated claims rose noticeably in the fourth quarter,
in line with the trend evident since mid-2004. Beginning at that time,
residents of the United Kingdom and offshore centres stepped up their yen
borrowing, suggesting an increased volume of yen-funded carry trades in 2005.
Lending to emerging economies was quite strong in the fourth quarter, driving a
net inflow of funds to emerging Europe and Latin America. International lending
to emerging markets has picked up in recent years, and has flowed to borrowers
with a lower average credit rating and on terms that are increasingly
advantageous to fund-raisers.
In contrast to emerging Europe and Latin America, large deposit placements in
BIS reporting banks were behind a record net outflow from Asia-Pacific. Such
placements have become more common in recent years, as a portion of Asia's
external surpluses is channelled through the international banking system.
Asia's deposits are an important source of funds for BIS reporting banks,
although only a small share of Asia's total funds invested abroad.
Special features
Securitisation in Asia and the Pacific: implications for liquidity and credit
risks
Securitisation can turn ordinarily illiquid assets into reasonably liquid
instruments, and create instruments of high credit quality out of debt of low
credit quality. In their review of securitisation in Asia and the Pacific,
Jacob Gyntelberg and Eli Remolona of the BIS document that Asian securitisation
has been based largely on the repackaging of residential mortgages and consumer
finance assets, and thus has been largely an activity for transforming
liquidity. The authors note that a higher degree of credit risk transformation
is often needed for corporate debt securitisation in Asia due to greater
recovery risk as well as less diversified collateral pools than in the US and
European markets. Even so, the authors suggest that there is great potential
for the securitisation of corporate debt in Asia, and that this would be
supported by the development of better accounting standards and disclosure
rules.
Domestic bond markets in Latin America: achievements and challenges
In recent years, domestic bond markets have constituted a growing source of
financing for Latin American economies. Drawing on statistics collected
primarily from national sources, Serge Jeanneau and Camilo Tovar of the BIS
argue that domestic bond markets have developed significantly, reflecting
factors such as more stable macroeconomic policies, improved predictability and
transparency of debt issuance, and the creation of liquid benchmark securities.
Notwithstanding these advances, a number of vulnerabilities persist. In
particular, the shift from external to domestic debt, which has helped reduce
the risks arising from currency mismatches, may have contributed to maturity
mismatches. Moreover, as the authors document, the investor base remains
narrow, hampering the development of secondary market liquidity.