Developing Government Securities Market Framework

and the case of Peru and the case of Peru

Developing Government Securities Market Framework

and the case of Peru and the case of Peru

Finance Forum 2002June 20, 2002

Clemente Del Valle FSD, World Bank Group

This Presentation will address the following questions:

• The importance of the topic and recent efforts of WB/IMF to support this development

• A summary of the main analytical framework being used to better organize such a developmental process

• How can the development of Peru’s govt bond market be better understood with this framework ?

• What are the implications to policy makers for future market development ?

• The importance of the topic and recent efforts of WB/IMF to support this development

• A summary of the main analytical framework being used to better organize such a developmental process

• How can the development of Peru’s govt bond market be better understood with this framework ?

• What are the implications to policy makers for future market development ?

Why is this topic important ?

Capital markets Capital markets complement bank financing contribute to the development of

multi-layered financial systems.

Capital markets Capital markets complement bank financing contribute to the development of

multi-layered financial systems.

Government bond marketsGovernment bond markets are the backbone of most fixed-income markets provide a number of positive external effects for

overall debt market development.

Government bond marketsGovernment bond markets are the backbone of most fixed-income markets provide a number of positive external effects for

overall debt market development.

Some external effects of government bond market development

Macro level:Macro level: non-inflationary funding of budget deficit, smooth transmission of monetary policies

Micro level: Micro level: stimulate development of financial infrastructure, products, and services

reduces exposure of portfolios to interest rates and exchange rates (derivatives).

Macro level:Macro level: non-inflationary funding of budget deficit, smooth transmission of monetary policies

Micro level: Micro level: stimulate development of financial infrastructure, products, and services

reduces exposure of portfolios to interest rates and exchange rates (derivatives).

What is the current state of local debt markets ?

Composition of domestic debt, Sept. 2000 % of total

0

20

40

60

80

100

Unite

d St

ates

Japa

n

Ger

man

y

Italy

Fran

ce

Unite

d Ki

ngdo

m

Spai

n

Braz

il

Sout

h Ko

rea

Chin

a

Arge

ntin

a

Mex

ico

Public Sector Financial Institutions CorporateSource: BIS

Domestic Markets in developing Countries remain substantially underdeveloped

Total Public Debt as % of GDP

04080

120160200

Mold

ova

Hunga

ry

Russia

Sloven

ia

Lithu

ania

Czech

Rep

ublic

Estonia

Jam

aica

Panam

a

Costa

Rica

Brazil

Urugu

ayChil

e

Mex

ico

Leba

non

Jord

an

Yemen

Algeria

Tunisi

a

Internal debt External debt

Recent Efforts to foster Government Bond Market Development

The objective The objective is tois to provide a comprehensive

vision. emphasize medium- and

long-term markets. highlight linkages with

other markets.

The objective The objective is tois to provide a comprehensive

vision. emphasize medium- and

long-term markets. highlight linkages with

other markets.

Recent Efforts to foster Government Bond Market Development

Disseminating activitiesDisseminating activities ( with IMF and WBI) LAC (Rio – June 2001),ECA( Istanbul March 2002),

MENA(Tunisia June 2002). Join forum with OECD (Washington March 2002)TA ProgramsTA Programs New TA debt management/GB markets programNew TA debt management/GB markets program Join TA missions with IMF (Egypt and Peru)Join TA missions with IMF (Egypt and Peru) Dedicated TA work ( China, Korea, Thailand, Brazil, Peru)Dedicated TA work ( China, Korea, Thailand, Brazil, Peru)

Disseminating activitiesDisseminating activities ( with IMF and WBI) LAC (Rio – June 2001),ECA( Istanbul March 2002),

MENA(Tunisia June 2002). Join forum with OECD (Washington March 2002)TA ProgramsTA Programs New TA debt management/GB markets programNew TA debt management/GB markets program Join TA missions with IMF (Egypt and Peru)Join TA missions with IMF (Egypt and Peru) Dedicated TA work ( China, Korea, Thailand, Brazil, Peru)Dedicated TA work ( China, Korea, Thailand, Brazil, Peru)

Level of financial sector development

Macroeconomic PolicyLegal framework and infrastructure

Issuer Investor

Intermediaries

Money markets

How can we understand Government Bond markets better?

The Conceptual Framework Part 1: “The Necessary Environment”

Level of financial sector development

Macroeconomic policy

PERU: Enabling environment

• Macroeconomic stability indicated by low inflation and current account deficit, built by prudent monetary and fiscal policy

• Yet, savings and transactions dollarized • Financial system concentrated and

fragmented• Small local currency institutional assets

• Macroeconomic stability indicated by low inflation and current account deficit, built by prudent monetary and fiscal policy

• Yet, savings and transactions dollarized • Financial system concentrated and

fragmented• Small local currency institutional assets

PERU: Government Bond Market

• S 500 million and S 700 million worth of government securities underwritten in 2000 and 2001 respectively

• S 1.8 billion govt securities being Dutch auctioned in 2002• Primary market: 2 fixed interest rate securities, with 2 & 3

year maturities. All dematerialized• 2 electronic transaction platforms for FX & securities

trades.• RTGS being introduced, will connect to private sector

depository

• S 500 million and S 700 million worth of government securities underwritten in 2000 and 2001 respectively

• S 1.8 billion govt securities being Dutch auctioned in 2002• Primary market: 2 fixed interest rate securities, with 2 & 3

year maturities. All dematerialized• 2 electronic transaction platforms for FX & securities

trades.• RTGS being introduced, will connect to private sector

depository

LAC: Fairly large markets moderately liquid

2

The market in Latin America: SizeTotal public debt / GDP

15

4130

1836

4

58

12 21 6 15 6 22

30 26

2071

48

14

56

3630

24

318

9

0

20

40

60

80

100

Arge

ntina

Braz

il

Chile

Colom

bia

Costa

Rica

Hond

uras

Jama

ica

Mexic

o

Pana

ma Peru

Urug

uay

Vene

zuela

Media

Internal External

December 2000

12

Liquidity of Latin American markets

Turnover (December 2000)

0

1

2

3

4

5

6

7

8

Arge

ntina

Braz

il

Chile

Colom

bia

Costa

Rica

Hond

uras

Mexic

o

Pana

ma Peru

Urug

uay

Vene

zuela

Aver

age

Internal External

Source: EMTA

LAC: Varied instrument mix, sizeable medium and long-term maturities

4

Internal debt by type of instrument (Dec. 2000)

0

20

40

60

80

100

Arge

ntina

Braz

il

Chile

Colom

bia

Costa

Rica

Jama

ica

Méx

ico

Pana

má

Perú

Vene

zuela Media

Fixed Variable Indexed

(% de

l total

)

The market in Latin America: Composition

5

Internal debt categorized by maturity

The market in Latin America: Composition

42.9

45.0

42.3

24.4

27.3

23.0

24.9

5.5

57.5

29.3

43.9

43.9

32.1

45.7

24.0

63.0

75.1

100.0

18.7

44.8

13.2

11.1

25.6

29.9

48.7

14.0

92.8

23.7

25.9

1.7

Argentina

Brazil

Chile

Colombia

Costa Rica

Jamaica

Mexico*

Panama

Peru

Uruguay

Media

Short term (<1 year) Medium term (>1year <5years) Long term (>=5 years)(% of total) December 2000

Conceptual Framework Part 2: “Basic Pillars and Prerequisites”

Institutional framework and infrastructure

Money market

Three Pillars of the Markets:

Institutional framework

• Separation of fiscal and monetary policy

• Clear mandates and governance of debt management

• Coordination among supervisors

Institutional framework

• Separation of fiscal and monetary policy

• Clear mandates and governance of debt management

• Coordination among supervisors

Market Infrastructure

• A secure and efficient clearing and settlement system

• Reduction of counterparty risk (DvP)

• An efficient depository system

Market Infrastructure

• A secure and efficient clearing and settlement system

• Reduction of counterparty risk (DvP)

• An efficient depository system

Money market and monetary policy

• Monetary policy through Open Market Operations

• Incentives for liquidity management among banks (interbank activity)

• A limited central bank credit facility for banks

• Sound government cash management

Money market and monetary policy

• Monetary policy through Open Market Operations

• Incentives for liquidity management among banks (interbank activity)

• A limited central bank credit facility for banks

• Sound government cash management

I II III

PERU: Institutional and Regulatory framework

• Clear mandate given to the MEF on public debt management • Current arrangement of MEF/Banco Nacion lacks of

transparency and real incentives for a better cash management • Conasev’s dual role of supervising and promoting market needs

to be clarified– separation between banking & fund management, and proprietary and

agency trading has been eroded – Improve rules to enhance independence of commissioners

• Multiple regulators and limited coordination by MEF has been the source inconsistence in regulation ( e.g.mark to market)

• Clear mandate given to the MEF on public debt management • Current arrangement of MEF/Banco Nacion lacks of

transparency and real incentives for a better cash management • Conasev’s dual role of supervising and promoting market needs

to be clarified– separation between banking & fund management, and proprietary and

agency trading has been eroded – Improve rules to enhance independence of commissioners

• Multiple regulators and limited coordination by MEF has been the source inconsistence in regulation ( e.g.mark to market)

PERU: Limited development of Money Markets

• Mostly unsecured overnight interbank markets• Very limited development of the term markets. BCRP

does not operate beyond the overnight• MEF’s unexpected resort to inter-bank financing via

Banco Nacion reduces capacity of BCRP to be flexible• Interbank rate hampered by limited availability of

securities for O/N repos• Standard repo contract, trading conventions, efficient

private clearing needed

• Mostly unsecured overnight interbank markets• Very limited development of the term markets. BCRP

does not operate beyond the overnight• MEF’s unexpected resort to inter-bank financing via

Banco Nacion reduces capacity of BCRP to be flexible• Interbank rate hampered by limited availability of

securities for O/N repos• Standard repo contract, trading conventions, efficient

private clearing needed

Issuer

Conceptual Framework Part 3:The Issuer

The Issuer should...

Be credible and have a medium- and long-term vision.

Have a strategy, that promotes development of the secondary market.

Be willing to operate through the markets and to accept the prices set by them.

Facilitate transparency (prompt information).

Build institutional capacity in the debt office ( market operations, risk management).

Be credible and have a medium- and long-term vision.

Have a strategy, that promotes development of the secondary market.

Be willing to operate through the markets and to accept the prices set by them.

Facilitate transparency (prompt information).

Build institutional capacity in the debt office ( market operations, risk management).

PERU as issuer: Debt management strategy

• There is no medium term debt management strategy• Domestic debt markets are still view as a residual

source• High exposure of the portfolio to F/X and to

refinancing risk . Limited diversification.• Current short term preference due to

– low credibility of economic policy, recent hyperinflation, – dollarized economy, illiquid markets along the yield curve

• There is limited internal capacity to interact with the market and design a medium term strategy.

• There is no medium term debt management strategy• Domestic debt markets are still view as a residual

source• High exposure of the portfolio to F/X and to

refinancing risk . Limited diversification.• Current short term preference due to

– low credibility of economic policy, recent hyperinflation, – dollarized economy, illiquid markets along the yield curve

• There is limited internal capacity to interact with the market and design a medium term strategy.

Conceptual Framework Part 4:The Investors

Investor

The Investor base should...

Be diversified to promote liquidity along the maturity structure.

Contain domestic and foreign institutional investors as well as individual investors.

Be diversified to promote liquidity along the maturity structure.

Contain domestic and foreign institutional investors as well as individual investors.

Investment funds and mutual funds are often the fastest-growing market segment and should therefore be a focus of reforms.

Investment funds and mutual funds are often the fastest-growing market segment and should therefore be a focus of reforms.

Conceptual Framework Part 5:Intermediaries and Markets

Issuer Investor

Intermediaries

Secondary market

Primary market

Primary market: Distribution channels

A strengthened capacity to interact with markets and market participants is necessary.

A system of primary dealers can facilitate the transition to “financing by the market.”

Direct distribution is a limited channel but has important externalities.

Auctions are often most cost-effective & transparent.

A strengthened capacity to interact with markets and market participants is necessary.

A system of primary dealers can facilitate the transition to “financing by the market.”

Direct distribution is a limited channel but has important externalities.

Auctions are often most cost-effective & transparent.

Secondary market: a demanding challenge

Ensure incentives that encourage transactions. investor diversificationa standard, fungible productintermediaries with risk management capacity

(market makers)Disclosure of information and an efficient trading

infrastructure

Electronic trading platforms can be useful if the underlying incentive structures are well designed.

Ensure incentives that encourage transactions. investor diversificationa standard, fungible productintermediaries with risk management capacity

(market makers)Disclosure of information and an efficient trading

infrastructure

Electronic trading platforms can be useful if the underlying incentive structures are well designed.

PERU: Building primary and secondary markets

• Auction preparation should be improved, considering effects on liquidity and market appetite

• Small volume of fungible instruments is an impediment to build more liquidity

• Increase transparency through wider dissemination of quotes, trade reporting and information standards

• Need of promote further diversification of investors; strengthen credibility of mutual funds

• Explore ways to encourage market making; a PD system + strong supervision to deal with concentration

• Auction preparation should be improved, considering effects on liquidity and market appetite

• Small volume of fungible instruments is an impediment to build more liquidity

• Increase transparency through wider dissemination of quotes, trade reporting and information standards

• Need of promote further diversification of investors; strengthen credibility of mutual funds

• Explore ways to encourage market making; a PD system + strong supervision to deal with concentration

How should reform plans be prioritized?

Depending on each country’s circumstances - size of its economy - sophistication of its financial system - its investor profile

Depending on each country’s circumstances - size of its economy - sophistication of its financial system - its investor profile

Short-termmeasures

Medium-term measures

DEVELOPED MARKET

CredibilityLowering of risks and costs

Security Liquidity

PERU: Leadership needed for developing market

• MEF needs to lead the development of – Coordination of the overall effort ( vice-minister)– Announce a clear medium term debt management strategy– Need to engage in a open dialogue with market participants( prior

to any formal PD system)• BCRP needs to lead the development of money markets

– Standardization of repo contract– Induce interbank activity in the term markets

• Need of strengthening overall financial supervision and eliminate sources of regulatory arbitrage and inconsistence

• MEF needs to lead the development of – Coordination of the overall effort ( vice-minister)– Announce a clear medium term debt management strategy– Need to engage in a open dialogue with market participants( prior

to any formal PD system)• BCRP needs to lead the development of money markets

– Standardization of repo contract– Induce interbank activity in the term markets

• Need of strengthening overall financial supervision and eliminate sources of regulatory arbitrage and inconsistence

Conclusion: Important Lessons for Policy Decisions

It is essential, to assess carefully and prioritize needs at the outset of

government bond market reforms, and to develop a formal and comprehensive strategy that will

accommodate multiple agents and policies.

It is essential, to assess carefully and prioritize needs at the outset of

government bond market reforms, and to develop a formal and comprehensive strategy that will

accommodate multiple agents and policies.

This process calls for organized, consistent management (e.g. by a high-level committee).

This process calls for organized, consistent management (e.g. by a high-level committee).

Thank You !Thank You !Thank You !Thank You !