Even though corporates have gone gangbusters issuing bonds since the start of the millennium, with new bond markets worldwide, the bond market’s luster may soon lessen for issuers, according to a research paper by staff from the International Organization of Securities Commissions (IOSCO).
“Corporate bond markets have almost tripled in size since 2000, reaching $49 trillion in 2013,” notes the 85-page report published in April, titled, “Corporate Bond Markets: A Global Perspective.” However, reduced bond-dealer inventories could be mean higher borrowing costs going forward, the paper also says.
Led by Rohini Tendulkar, an economist in the IOSCO Research Department, the research found that bond financing as a percentage of GDP has increased, averaging 169 percent for developed markets and 24 percent for emerging markets, much of it the result of multinationals looking to avoid foreign-exchange risk. “The deepening markets can suggest increasing reliance on corporate bond markets to meet the financing needs of an economy,” the paper says.
Developed markets accounted for 92 percent of the global corporate bond market’s size. Removing the outstanding bonds issued by financial firms narrows the gap between developed and emerging corporate bond markets, but there nevertheless remains a large disparity in size between the largest and smallest bond markets. The total of outstanding bonds of the US was $21 trillion, while the market size for the next 10 largest markets averaged $2 trillion; the size of the 10 smallest bond markets averaged $18 billion.
The study, which culled data from seven sources including Bloomberg, the IMF and the World Bank, found that corporate bond financing increased as a proportion of total global corporate financing, although not significantly. It was 25 percent in 2012, up from 24 percent in 2004, while bank lending continued to dominate corporate finance, with a 52 percent share in 2012.
In addition, corporate bond issuance has grown steadily since 2000, despite the financial crisis. The paper says the compound annual growth rate (CAGR) between 2000 and 2007, was 12 percent for financial issuers and 8 percent for corporates. After the financial crisis struck in 2008, corporates’ CAGR continued at the same pace, while financial companies’ CAGR dipped into negative territory.
Corporate bonds have been issued for the first time from 27 economies since 2000—most of them emerging markets, which made up 30 percent of global issuances in 2013 compared to just 5 percent in 2000, the report says. That’s a major benefit to corporate issuers operating in those countries, since issuing local currency bonds tends to be a more stable source of financing because it eliminates foreign-exchange risk. The report found that the majority of issuances globally have tended to be in the local currency, and even more so in the wake of the financial crisis.
A secular trend that appears to be gaining steam is corporates’ increasing reliance on market-based financing, including bonds. “Analysis of the data reveals that corporate bond market financing is substituting bank financing in some developed markets,” the paper says. It adds that bank lending to corporates “declined markedly” in the wake of the financial crisis, and that higher capital requirements stemming from Basel III and other regulations will likely exacerbate the trend.
Historically low interest rates since the onset of the financial crisis have resulted in a wider selection of financing tools, as investors search for yield. Relatively new or re-emerging bond instruments, including payment-in-kind as well as contingent convertible and write-down bonds, have seen strong increases in volume over the last few years, although they remain a small fraction of the overall market. Nevertheless, the paper notes, they introduce additional risk and the potential for market manipulation.
The financial markets are still digesting new regulations stemming from the financial crisis, but one consequence has been a sharp reduction bond-dealer inventories, from a high of more than $230 billion in late 2007 to around $50 billion in 2013. Although bond rates have been at historic lows in recent years, as central banks have sought to inject liquidity into economies and investors demand has tightened spreads, that could change soon and ramp up financing costs for corporates.
Dealer’s reduced inventories could signal less ability for the secondary market to absorb shocks in the case of a widespread bond sell-off, which could occur as interest rates rise.
“After this period of adjustment, new investors will most likely seek higher compensation for the liquidity they face,” the paper says, adding. “This means that issuing firms may have to price higher liquidity into the bond yield offered—increasing the cost of borrowing.”