International Bond MarketsUluslararası Tahvil Piyasaları

BY MONZUR MORSHED PATWARY

Bonds vs International Bonds A bond is a long-term debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.International bonds The same as normal bonds. But the key concept is that international bonds are issued either in a currency other than that of the country in which they are issued or by an issuer that doesn’t reside in the country in which they are issued.

What is the International Bond Market Generally, every country has two bond markets: An Internal one and

an External one. The worldwide framework of the domestic (internal) bond market. A type of Fixed Income Investments Also called the global bond market, allows investors to diversify their

portfolio, preserve their wealth, and see attractive returns on their investment.

International bond markets are NOT unified into a single market (like FX and Eurocurrency market), they can be done OTC.

Bonds can range from extremely low risk to extremely high risk, with risks at all levels in between.

What we don’t know about the International Bond Market

International Bond Market is very big and has an estimated size of more than 60 trillion dollars, and the size of the US bond market is the largest in the world. The US bond market's outstanding debt is more than $25 trillion.

There are bonds from many developing countries that may offer excellent returns. This is because international bonds from developing nations may be somewhat riskier.

The four major currencies used to denominate bonds are :1. Euro 1. U.S. dollar 3. British pound sterling 4. Japanese yen.

International Bond Markets Volume Outstanding

This chart shows the number of deals and the volume in USD trillions outstanding in the international debt capital markets at end of Q4 2011 to end of Q4 2015.  

Top 15 International Bond Market Volume by Currency

This chart shows the international debt capital markets volume by currency at end of 4th quarter 2015.

The Primary and the Secondary Market This market trades in a large number of bond types

each day, and is separated into two distinct markets :1. Primary bond market (new issues ) :where bonds are issued for the 1st time from an issuing entity and then sold to lenders2. Secondary bond market (used issues- resale)is where the investors who have bought bonds from the issuing entity go to sell these bonds, and where buyers looking for these bonds go. The stock market is small compared to the international bond market, even though the stock market is more well known to the public.

Bond Market Association The Bond Market Association was considered as the association for

international trade and bond market industry. Its headquarters were situated in London, New York and in Washington and

nearly 20% of of the total percentage of membership were placed outside America.

The Bond Market Association had worked like the global representative for those who issue bonds and trade with them

Played a big role in co-ordinating with governments,corporations and with the investors as well.

Bond Market association in the International Bond Market also had a code of conduct which the market participants had to follow very strictly.

In the year 2006, the Bond Market Association was merged with Securities Industry Association which formed a new institution called the Securities Industry and Financial Markets Association. 

The Structure of International Bond Market The International Bond Market is an investment market just like the stock market, but

there are some differences in the structure of these two markets. The usual trading of bonds occurs on the over the counter market, and not on the

exchanges like stocks are. The structure of the international bond market is all electronic.

There are a few corporate bonds which are the exception, because these may be traded on the exchanges.

Bonds are normally traded using networks, which are set up to utilize electronic trading. Unlike the stock market, whose physical location is on Wall Street, there is no physical

marketplace for the bond market. Instead, computers and telephones are used to buy, sell, and trade bonds. The international bond market structure is continuously evolving and growing, and the

number of bonds being traded is on the rise. This market is a good opportunity for investors to diversify their portfolio and invest in foreign markets at the same time.

Security Regulations That Ease Bond Issuance

1. Shelf Registration (SEC Rule 415)- Allows the issuer to preregister a securities issue, and then offer the securities when the financing is actually needed.

2. SEC Rule 144A - Allows qualified institutional investors to trade private placements.- These issues do not have to meet the strict information disclosure requirements of publicly traded issues.

International Bond Market participantsInternational Bond Market participants are either buyers (debt issuers) or sellers (institutions) of funds and often both of them. Participants include − Institutional investors Governments Traders IndividualsSince there is a specificity (quality) of individual bond issues, and a condition of lack of liquidity in case of many smaller issues, a significantly larger chunk of outstanding bonds are often held by institutions, such as pension funds, banks, and mutual funds.

Segments of the International BondsDivided into four separate segments :

- Sovereign Bonds - Foreign Bonds - Global Bonds- Eurobonds

1. Sovereign Bonds Bonds issued by a country's central government. Tend to be the largest sector of a bond market in any country. They can be issued in their home country, the Eurobond market or the

foreign sector of another country. They are typically denominated in the home country's currency, however, but

they are not required to be. Countries with an unstable economy tend to denominate its bonds in the

currency of a country with a stable economy. (Ex: Developing Countires having emerging markets such as those in Africa, Asia, Latin America, Middle East, Russia, and eastern/southern Europe ).

2. Foreign Bonds

Type 1 Bonds Issued by foreign entity Outside the country where the entity resides Denominated IN THE currency of the country where issued Example:

Toyota issues $ denominated bonds in USA.Type 2 Bonds Issued by foreign entity Outside the country where the entity resides Denominated in currency OTHER THAN THAT of the country where

issued Example:

Toyota issues Yen denominated bonds in USA

Foreign Bonds can be issued in any currency and can have colorful nicknames such as :1. Yankee Bonds Foreign Bonds sold in U.S. (Attract the max num of issuance)2. Samurai Bonds Foreign Bonds sold in Japan. (Attract the max num of issuance)

3. Bulldog Bonds Foreign Bonds sold in U.K. 4. Rembrandt Bonds Foreign Bonds sold in Netherland. 5. Matador Bonds Foreign Bonds sold in Spain.6. Maple Bonds Foreign Bonds sold in Canada.7. Kangaroo Bonds Foreign Bonds sold in Australia.8. Supranational BondsIssued when two or more central governments issue foreign bonds to promote economic development for the member countries. These include bonds issued by the International Bank for Reconstruction and Development, or World Bank, and the International American Development Bank.

3. Global Bonds

Similar to Foreign bonds market, But issued in many different countries and sold worldwide

(practically: North America, Europe, Asia) Denominated in 1 or many currencies and can be issued in the

same currency as the country of issuance. Registered in each market where issued.

–  Global bond issues were first offered in 1989. Typically Issued by international companies that possess high

credit ratings.

Ex : Deutsche Telekom Global Bond

The largest corporate global bond issue Deutsche Telekom multicurrency offering reached the $14.6 billion.

The issue includes :

Three U.S. dollar tranches with 5, 10, and 30 year maturities totaling $9.5 billion,

Two euro tranches with 5 and 10 year maturities totaling €3 billion, Two British pound sterling tranches with 5 and 30 year maturities totaling

£950 million, One 5 year Japanese yen tranche of ¥90 billion.

4. EuroBonds Differ from the others in that; Bonds are not sold in any national bond

market. Issued by a group of multinational banks. If a Eurobond is designated in any currency, it would be sold

outside the country which uses that currency. Ex : if a Eurobond is denominated in the US $ , it would not be sold

in the US. Very Preferable because it has comparatively lower costs and

lower regulations. Example 1 :

Toyota issues Yen-denominated bonds in “offshore” market. (Foreign Banks or corporations located outside of one’s national boundaries).

EUROYEN Bond

EuroBondsExample 2 :Swiss borrower issues $ denominated bonds to investors in UK, India,and Japan.

Bearer Bonds Bonds with no registered owner. They offer anonymity but they also offer the same risk of loss as currency.Registered BondsThe owner’s name is registered with the issuer.Ex:U.S. security laws require Yankee bonds sold to U.S. citizens to be registered.

Eurobond Practices in the Primary Market

A borrower desiring to raise funds by issuing Eurobonds to the investing public, and will contact an investment banker and ask it to serve as the lead manager of an underwriting syndicate that will bring the bonds to market.

The underwriting syndicate is a group of investment banks, merchant banks, and the merchant banking arms of commercial banks that specialize in some phase of a public issuance.

The lead manager will sometimes invite co-managers to form a managing group to help negotiate terms with the borrower, as certain market conditions, and manage the issuance.

Eurobond Practices in the Primary Market The managing group, along with other banks, will serve as

underwriters for the issue, that is, they will commit their own capital to buy the issue from the borrower at a discount from the issue price.

The discount, or underwriting spread, is typically in the 2 to 2.5 percent range.

Most of the underwriters, along with other banks, will be part of a selling group that sells the bonds to the investing public.

Eurobond Practices in the Secondary Market

Eurobonds initially purchased in the primary market from a member of the selling group, and may be resold prior to their maturities to other investors in the secondary market.

The secondary market for Eurobonds is an OTC market with principal trading in London. However, important trading is also done in other major European money centers, such as Zurich, Luxembourg, Frankfurt, and Amsterdam.

The secondary market comprises market makers and brokers connected by an array of telecommunications equipment.

Market makers stand ready to buy or sell for their own account by quoting two-way bid and ask prices.

Market makers trade directly with one another, through a broker, or with retail customers. The bid-ask spread represent market makers’ only profit; no other

commission is charged

Clearing Procedures

Eurobond transactions in the secondary market require a system for transferring ownership and payment from one party to another.

Two major clearing systems, Euroclear and Clearstream International, handle most Eurobond trades.

Euroclear is based in Brussels and is operated by Euroclear Bank. Clearstream is located in Luxembourg. Both clearing systems operate in a similar manner.

Each clearing system has a group of depository banks that physically store bond certificates.

Members of either system hold cash and bond accounts. When a transaction is conducted, electronic book entries are made that transfer book ownership of the bond certificates from the seller to the buyer and transfer funds from the purchaser’s cash account to the seller’s.

Other Functions of the Clearing System

Euroclear and Clearstream perform other functions associated with the efficient operation of the Eurobond market.

1. The clearing systems will finance up to 90 percent of the inventory that a Eurobond market maker has deposited within the system.2. The clearing systems will assist in the distribution of a new bond issue. The clearing systems will take physical possession of the newly printed bond certificates in the depository, collect subscription payments from the purchasers, and record ownership of the bonds. 3. The clearing systems will also distribute coupon payments. The borrower pays to the clearing system the coupon interest due on the portion of the issue held in the depository, which in turn credits the appropriate amounts to the bond owners’ cash accounts.

International Bonds Market Instruments

1. Straight Fixed Rate Debt2. Floating-Rate Notes3. Zero Coupon Bonds4. Equity-Related Bonds5. Dual-Currency Bonds6. Composite currency bonds

1. Straight Fixed Rate Debt

Also called “plain vanilla” bonds, come with a specified coupon rate and maturity, and no options attached.

 Pays a regular fixed interest rate over a fixed period of time to maturity with the return of principal on the maturity date.

Since most Eurobonds are bearer bonds, coupon dates tend to be annual rather than semi-annual.

The vast majority of new international bond offerings are straight fixed-rate issues.

2. Floating-Rate Notes

Just like an adjustable rate mortgage. Interest rate is tied to a reference rate such as LIBOR or EURIBOR.

Sometimes called Floating-rate notes, FRNs, or floaters. Common reference rates are 3-month and 6-month U.S. dollar LIBOR Since FRN reset every 6 or 12 months, the premium or discount is

usually quite small“as long as there is no change in the default risk”

3. Zero Coupon Bonds

Do not carry a coupon; the return on the bond comes from the fact that they are sold at a significant discount to the eventual redemption value.

Zeros are sold at a large discount from face value because there is no cash flow until maturity.

In the U.S. investors in zeros owe taxes on the “imputed income” represented by the increase in present value each year, while in Japan, the gain is a tax-free capital gain.

Pricing is very straightforward:PV =

PAR(1 + r)T

4. Equity-Related BondsThere are two types of Equity-Related Bonds: Convertible bonds and Bonds with Equity Warrants :

Convertible Bonds : A convertible bond issue allows the investor to exchange the bond for

a predetermined number of equity shares of the issuer. The floor-value of a convertible bond is its straight fixed-rate bond

value. Convertibles usually sell at a premium above the larger of their straight debt

value and their conversion value. Investors are usually willing to accept a lower coupon rate of interest

than the comparable straight fixed coupon bond rate because they find the conversion feature attractive.

4. Equity-Related Bonds Bonds with Equity Warrants :

These bonds allow the holder to keep his bond but still buy a specified number of shares in the firm of the issuer at a specified price. They can be viewed as straight fixed-rate bonds with the addition of a call option

(or warrant) feature. The warrant entitles the bondholder to purchase a certain number of equity shares

in the issuer at a prestated cash price over a predetermined period of time.

With a convertible bond, we surrender the bond to get the shares. But in Bonds with Equity Warrants we pay cash to get shares and keep the bond.

5. Dual-Currency Bonds Bonds in which principal payments are in one currency and coupon

payments (Interest payments)are in another currency.  Japanese firms have been big issuers with coupons in yen and

principal in dollars. Good option for a Multinational Companies financing a foreign

subsidiary.

0 1 3 4 NN – 1

¥ ¥ ¥ $¥

6. Composite currency bonds  Portfolios of currencies: while some currencies are depreciating

others may be appreciating, thus yielding lower variability overall.

Denominated in a currency basket, like the SDRs or ECUs instead of a single currency.

Often called currency cocktail bonds. Typically straight fixed rate debt.

Instrument

1. Straight Fixed-Rate

2. Floating Rate Note

3. Convertible Bond Annual Fixed Currency of issue or conversion to equity shares.

4. Straight fixed rate with equity warrants

Annual Fixed Currency of issue plus conversion to equity shares.

5. Zero Coupon Bond none zero Currency of issue

6. Dual Currency Bond Annual Fixed Dual currency

Frequency of Payment

Annual

Size of Coupon

Payoff at Maturity

Characteristics of International Bond Market Instruments

Currency of issueFixed

Every 3 or 6 months Variable Currency of issue

The International Bond Market in Turkey

The most used instrument is »Eurobond» that issued by : the Turkish Undersecretariat of Treasury, Türkiye Cumhuriyeti Hazinesi tarafından. They are listed by Borsa İstanbul and traded in Internatioanal Bonds Market. Since the Turkish eurobond market opened in early 2011, banks and corporates are

now allowed to issue eurobonds directly without having to pay withholding tax on interest payments under the bonds. This change in law, along with the favourable market conditions, has encouraged many Turkish issuers (predominantly banks) to come to market.

Trading in the International Bonds Market in Turkey is conducted electronically via the “multiple price - continuous auction” system.

Orders in the same currency are matched, and trading orders are transmitted in the currency of issue of the security over a price base of 100 units.

On the market, future value dated transactions can be conducted up to no less than 1 business day and no more than 15 calender days.

International Bond Market Credit Ratings Fitch IBCA, Moody’s and Standard & Poor’s provide credit ratings on most

international bond issues. They focus on default risk, not exchange rate risk.

In rating Sovereign Bonds, S&P’s analysis centers around an examination of: political risk, income and economic structure, economic growthprospects, fiscal flexibility, general government debt burden, offshore and contingent liabilities, monetary flexibility, external liquidity, public-sector external debt burden, and private-sector debt burden.

It has been noted that a disproportionate share of international bonds have high credit ratings.

The evidence suggests that a logical reason for this is that the Eurobond market is only accessible to firms that have good credit ratings to begin with.

International Bond Market Indices A bond index or bond market index is a method of measuring the value of a section of

the bond market. It is computed from the prices of selected bonds (typically a weighted average). It is a tool used by investors and financial managers to describe the market, and to compare the return on specific investments.

International Bond Market Indices :1. (Bank of America) Merrill Lynch Global Bond Index2. Barclays Capital Aggregate Bond Index3. Citi World Broad Investment-Grade Bond Index (WorldBIG) Government Bond Indices :1. Barclays Inflation-Linked Euro Government Bond Index2. Citi World Government Bond Index (WGBI)3. FTSE UK Gilts Index Series4. J.P. Morgan Government Bond Index