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Global Bond Markets and its Impact

A well-functioning and self-sustaining capital market is an advanced economy’s underlying building block. Global bond markets are one of the most significant enablers within the capital markets. Capital markets, predominantly debt and equity, are vehicles for the critical functioning of the market and economy and provide liquidity, depth, transparency, the legal and regulatory framework for a smooth and continuous flow of credit across actors. As economies become more mature, capital markets become more sophisticated, and intangible factors become more prominent, including increased financial innovation, a tradition of public ownership and enhanced culture of trading, etc. As capital markets develop, they undergo two phases of development; an early and late phase. In the process, the role of operation infrastructure, policy analysis, its implementation, legal and regulatory enforcement, domestic investors, especially institutions, is paramount in driving participation among foreign (ancillary players) and retail investors. Furthermore, markets serve as a backbone for funding central/federal and state-level deficits and as a mechanism for raising capital for corporates. And yet one of the critical functions of the capital markets is to judiciously allocate capital optimally across the society significantly micro, small, and medium enterprises which remain underserved even in advanced economies. However, one key aspect often overlooked is the importance of a stable risk-free rate. With capital markets, debt markets are more prominent than equity capital markets. The bond market, which dominates the debt market, is skewed towards the sovereigns. To have stable debt capital markets, low, stable yields on treasuries are vital measures to keep funding stable. The risk-free rate is the benchmark for estimating expected return and market premium on risky assets. A high risk-free rate makes funding more expensive, making projects unviable to implement. Second, the depth of the bond market does matter to some degree for driving liquidity within the system. According to BIS, a minimum of $100 million to $200 million of outstanding government bonds facilitates the government bond market to function. Both Singapore and Hong Kong government used government and exchange fund paper to build the debt market. 2  

Its imperative to understand how the bond markets functions to understand the sustained social change and impact of capital markets within the global ecosystem. This article builds and complements the first tutorial on Global Bond markets published under the Tutorial section on The middle Road..

The global bond markets play a pivotal role in enabling sustainable change and impact within the world. The international bond market with outstanding issuance stands at $128.3 trillion. With the sovereign bond market valued at ~ $64 trillion, the Government remains the most significant player in the debt markets. Apart from the Government, Corporates, Municipalities, Agencies, and Supranational organizations play a substantial role in issuing bonds in the secondary market. The size of the listed global equity markets globally stood at $60.3 trillion by the end of 2019, highlighting the enormous leverage of the fixed-income securities in moving credit within the economy. Both equity and bonds are tools for all actors to raise capital from the capital markets. Central/ Federal governments use Sovereign bond markets to fund expenditure to tide over deficits or provide stimulus during adverse situations. Debt capital markets facilitate smooth movement of credit within an economy, fund expansion plans of both economies and corporates, interconnect various actors within the business and social ecosystem for enhancing socio-economic development, foster innovation to deliver an efficient expansive basket of solutions and products to consumers with a measurable impact. On the other hand, poorly regulated and managed capital markets create global panic through recessions and inequitable distribution of wealth. The 2008 subprime crisis is an excellent example of debt markets’ destructive power, especially the use of derivatives within the collateralized debt markets. Apart from the central Government, municipalities, especially state and local governments and their authorized agencies use capital markets to raise capital for long-term, capital-intensive projects, especially in the development and infrastructure sector. In recent years, Supranational organizations, especially multilateral banks, have been using capital markets by issuing sustainable bonds for international development work. Supranational organizations are wide-ranging global organizations formed by two or more central banks backed by international treaties (Fabozzi), usually to promote global development work.

Inter-American Development Bank and Asia Development Bank are excellent examples of multilateral development banks forming part of the Supranational group. With the scarcity of capital and market failures in the social sector, these organizations will play a much more significant role in enabling social change and impact within society.

# Actors and selected types of bonds within the Global Bond Market 

US, China, Japan, and the EU are the largest issuers of outstanding bonds globally with respective issuance of $22.4, $19.8, 12.4, and 12.2 trillion as of August 2020 based on ICMA and Bloomberg data. Although the corporate sector is the second largest in outstanding bonds issuance data, Agencies are critical players in the debt capital, driving mortgage and asset-backed securities innovation. Mortgage securities are residential and corporate mortgages, while ABS includes credit card and car loan payments. The securitization sector works as a double-edged sword; on the one hand, it spreads the risk of mortgages among a comprehensive set of investors, diversifying risk and making mortgages cheaper and universally available. At the same time, collateralized mortgage obligations use derivatives to further customize loans into tranches with varying risk to satiate various risk profiles. Difficult to comprehend and manage their risk, these structures work like steroids for catastrophe when fuelled with leverage. CMOs’ subprime tranches were the central piece of the credit crisis which almost brought down the house and ensured economic turmoil. Securitization covers the Covered bond market, which also pools mortgages and public loans as collateral for constructing loans are hugely popular in Europe. Estimated to be about Euro 2.4 trillion, covered bonds are different in a few aspects from the residential and commercial backed securities in the US. Unlike in the US, covered bonds assets are on the balance sheet of banks rather than a special purpose vehicle used to offload securities loans from the issuer book. This feature enables higher accountability and transparency, ensuring recourse for bondholders during bankruptcy. Further, the pool of assets within the parlance of the covered bond market is dynamic rather than static, to mention a couple of noteworthy differences between the two.

Refer to the webinar by Nishant Malhotra for Atal Innovation Mission on this subject here.

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