Corporate Upgrades Propel Local-Currency Bond Issues

Emerging Markets

Corporate bond markets denominated in domestic currencies are developing rapidly in many emerging markets, enabling local companies to issue debt without having to worry about repaying it in revalued dollars. While pension funds and insurance companies based in emerging markets are rapidly expanding their investments in local corporate debt, international investors are only beginning to nibble at the edges of this nascent EM asset class. The market is growing rapidly, but is not easy for outsiders to access without legal and tax experts. And while the yields are attractive, global investors are forced to shoulder the inflation and currency risk, as well as the sovereign and corporate risk.

Anne Milne, head of global emerging markets corporate credit at Bank of America Merrill Lynch Global Research, says: “Ratings upgrades have been a big driver of growth in emerging market corporate bond markets. In 1999, the average EM corporate rating was BB-, and it has increased steadily since then. Today, the average corporate rating for these bonds is BBB,” just enough to make them investment grade.

Improving fundamentals and attractive valuations are beginning to put local non-sovereign debt from EM corporations and agencies on the radar screens of global investors, Milne says. Nearly a year ago, BAML introduced a group of indices that track the performance of local currency corporate bonds, helping to increase their visibility.

The EM corporate bond market denominated in hard currencies has been growing at a rate of more than 25% annually for the past 10 years, and now totals more than $1.5 trillion, far surpassing the level of external sovereign bonds. There are now $4.2 trillion of local-currency corporate bonds outstanding in emerging markets, versus $3.9 trillion of local sovereign bonds.

The bigger the market for local-currency corporates gets, the more likely it is to attract global investors looking to diversify their portfolios, says Javier Montero, Latin America fixed-income portfolio manager at Moneda Asset Management, based in Santiago, Chile. Moneda was a first mover five years ago, when it introduced a dedicated Latin America corporate bond fund in local currencies.

“Issuing bonds in local currencies takes out the exchange-rate risk, one of the major risks for corporations in the region,” Montero says. “Today’s corporate debt stock in local currency is around 2.2 times the stock in hard currency.”

Meanwhile, local pension funds and insurers in emerging markets¾with liabilities in local currencies¾are expanding and have healthy inflows supported by favorable demographics, Montero says. This makes them eager buyers of local-currency bonds. “It may take time for the local corporate market to go mainstream with global investors, but it will get there,” Montero says.

Local EM corporates are out of reach for many global investors, who prefer to have their corporate bond purchases processed through Euroclear, says Phil Galdi, managing director of global bond indices at BAML Global Research. As of September 30, only about $250 billion of the $4.2 trillion of local non-sovereign EM debt outstanding was eligible to be processed by Euroclear. Many corporations do not need to get ratings in order to issue bonds in the local market, Galdi says. “Now they have an incentive to make their bonds Euroclearable,” he says.