Arjoon Harripaul, Contributor
HARRIPAUL
THE BOND market or the debt market as it is loosely called, represents those institutions and arrangements that deal with long-term debt instruments such as bonds, medium-term notes and subordinated debt.
Well-functioning bond markets form an important part of any modern economy. While equity markets provide companies with risk capital, bond markets support the capital structure of firms by providing debt funds.
Bond financing is an alternative source of funds to bank loans. The bond market allows a borrower to directly access funds from multiple investors, usually at lower interest rates and with greater structuring flexibility than traditional bank loans.
From the other side of the transaction coin, bond markets provide greater investment opportunities for institutional investors and retail investors. Bond markets, with functioning credit rating mechanisms, also yield a systemic benefit of greater transparency and disclosure and encourage improved fiscal discipline among issuers.
What are the key ingredients of a well functioning bond market?
A necessary precursor for any effective bond market is a well functioning, highly liquid government bond market to serve as a benchmark against which all other fixed-income securities can be priced. To ensure that the government bond market can continue to provide the benchmark yield curve, the supply of government bonds must be regular, predictable and transparent.
Apart from a proper government bond market, there are several other key ingredients necessary for the accelerated development of bond markets in the Caribbean. Without these ingredients, it is questionable whether a bond market can actually be functional enough to deliver economic benefits.
Firstly, the market must be sufficiently wide. That is, there must be a variety of instruments available. There is a very small amount of commercial paper activity, and only a handful of structured obligations have been brought to the market.
Secondly, there must also be depth in the market. In other words, the robustness of the investor base must be assured. In order to function well, a bond market needs investors with different demand profiles who will provide a steady stream of long-term demand for different kinds of bonds. Investors must also be willing to trade in these securities.
INSTITUTIONS INVEST IN MARKET
At present, institutional investors account for the lion's share of bond market activity. The retail investor base is very thin and functions mostly through pooled mutual funds. Any market characterised by a small number of investors (and intermediaries) can lead to market imperfections and anomalies.
For instance, a Government of Trinidad and Tobago 15 year bond issued in September 2004 with a coupon rate of 6.1 per cent that compares with an Airports Authority of Trinidad and Tobago 15 year bond issued in January 2005 with a coupon rate of 5.75 per cent should raise some questions.
Thirdly, the market infrastructure both operational and legal must be developed. Operational elements include complete systems for bond trading, clearing and settlement, as well as hedging and credit rating systems. While reasonable bond trading arrangements exist, clearing and settlement, hedging, and credit rating systems are yet to be comprehensively implemented.
The regulatory environment also needs to be re-examined to focus more on maintaining and enhancing transparency and market integrity. Inter alia, this involves requiring clear, complete, timely and meaningful disclosure; promoting good corporate governance; and formulating and enforcing clear and sound market rules and regulations.
BOND MARKET LIMITS
Given their small size, most of the Caribbean's bond markets face serious limits to liquidity, efficiency and growth. Therefore, the region's economies would benefit from greater cross-border issuance and investment and a commercially driven regional bond market. Such a market would enable borrowers to directly tap the relatively large savings within the region and may also attract international investors.
Of course, the regionalization of the Caribbean's bond markets brings with it further challenges such as more flexible exchange rate arrangements, measures to guard against dangerously volatile capital flows, regional policy coordination and facilities to both measure and enhance regional credits.
Domestic bond markets in the region are still, for the most part, nascent while a fully functional regional bond market is still some way off.
Closer to home, it has been observed how fairly developed domestic bond markets in Jamaica helped the government to raise funds domestically and thus stave off a foreign exchange payment problem. This domestic funding option was not available to the Dominican Republic in its recent crisis.
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