University of New South Wales Faculty of Law Research Series
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University of New South Wales Faculty of Law Research Series |
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A Force for Globalisation:
Emerging Markets Debt Trading from 1994 to 1999
By
Ross P
Buckley[1]
Forthcoming, Fordham International Law Journal.
This paper analyses the development of the secondary market in emerging markets debt from 1994 to 1999, and identifies the lessons to be learnt from that period. Particular attention is paid to the increasing integration of the secondary market with traditional financial markets, and to the force for globalisation that this secondary market therefore exerted in the period.
The secondary market in emerging markets debt is based in New York and London and grew out of the swapping among banks in 1983 of the loans of the debt crisis. The author has previously chronicled the development of the market from 1983 to 1993,[2] and analysed several of its aspects.[3] This paper analyses the market history 1994-1999, identifying the lessons learnt from that period of market development. Particular attention is paid to the increasing integration of the secondary market for emerging markets debt with traditional financial markets, and to the force for globalisation that this secondary market therefore exerted in the period.
The year, 1993, witnessed an extraordinary bull run in the secondary market for emerging markets debt.[4] The bull market continued through the New Year into 1994 with the Salomon Brady bond index jumping an extraordinary 15.75 percent in January, 1994.[5] In that month there was a revolt in Chiapas, Mexico’s southernmost state, but the market’s upward trend barely hesitated, at the time, on this evidence of political instability. It was the risk of inflation to Mexico’s north, not ill-treated peasants in its south, that was to end the bull run.
Notwithstanding the strong performance in January, by June 1994 the Salomon Brady bond index had fallen 33 percent for the year[6] and loan prices had fallen further with Russian and Peruvian loans down almost 50 percent.[7] The magnitude of these price falls owed much to their inflated values at the end of 1993. The boom of 1993 had been fuelled in part by low interest rates in the U.S. that saw fund managers and other investors seeking higher returns in the emerging markets. The turnaround in this interest rate environment was the major factor in the market collapse of 1994. The other important factors were the excesses of 1993, particularly excessive leverage, and the political risks displayed in Mexico and Venezuela. Each will be considered.
On February 4, 1994, in an effort to curb potential inflationary pressures, the U.S. Federal Reserve increased short-term interest rates.[8] The rates continued to climb throughout 1994.[9] As interest rates rose, U.S. Treasury bond prices fell accordingly, and emerging market bonds, which had for some time been priced at margins above U.S. Treasuries,[10] fell precipitately. This movement was exacerbated by the narrowing in 1993 of the spread between emerging market and U.S. Treasury bonds: while the yield on the US long bond declined some 104 basis points in 1993, the spread between it and emerging markets bonds, on average, declined a dramatic 413 basis points.[11] As U.S. rates moved upwards in 1994, and U.S. long term rates rose 126 basis points in the first half of the year,[12] investors suddenly found the price differential between emerging market and U.S. instruments grossly inadequate to compensate for the increasing risk on display south of the border.
The bull run of 1993 was, by any measures, extraordinary. The Salomon Brady bond index rose 44 percent during 1993, and a further 15 percent in January, 1994.[13] The prices of many loans increased even more dramatically. Peruvian loans, which had sold for 20 cents on the dollar in early 1993, were trading above 70 cents in early 1994.[14] Peru was not servicing its loans, so these prices were a gamble on a Brady-style restructuring in which Peru would decide to meet its obligations. Russian loans were at equally unrealistic prices.[15] However, recent restructurings had proven notoriously slow to complete. Brazil’s had required over a year longer than anyone anticipated. Paying these prices for non-performing loans purely in anticipation of a restructuring was unalloyed, high-risk speculation.
Many market investors were also highly leveraged in 1993.[16] As Bill Nightingale said,
The US stock and bond markets have regulatory limits on how much systematic leverage there can be -- the emerging markets have none. It’s purely between the investors and the dealers to determine how much leverage they want to take. There was a hell of a lot in this market, and probably much more than ... in any well-regulated market.[17]
Hedge funds and other risk-friendly institutional investors had taken large positions in Brady bonds on margin. A number of banks had leveraged their clients, both institutional and individual investors, by up to 900 percent.[18] These investors tended to look upon Brady bonds as high liquidity instruments that could be sold immediately upon a change in the interest rate environment.[19] However, in a falling market, buyers proved to be very scarce indeed. The depth of panic in the market is evidenced by the fact that the prices of floating-rate Brady bonds fell virtually as far as fixed-rate Bradys, even though floating-rate bonds that trade at deep discounts would normally rise in value in a rising interest rate environment.[20] Buyers were simply too rare to support the market.
In addition to the investors who were forced to sell to meet margin calls, others who had purchased Brazil’s when-and-if-issued Brady bonds at high prices in late 1993 also had to sell as market prices were substantially lower when completion of the long-awaited restructuring neared.[21] Counterparty defaults added further to trader’s losses in 1994. Many participants had joined the market in the bull run and had no experience of, and inadequate capital to withstand, an emerging markets collapse. The resulting defaults made trading even more expensive and difficult for the remaining participants.[22]
In summary, in the bull run of 1993 investors forgot the historical volatility of emerging markets and their history of defaulting on their debts. Brady bonds were liquid instruments, traded in Euroclear and Cedel, and it was all too easy to believe that there would be buyers when one wanted, or needed, to sell.[23] However, many of the institutional investors which had discovered emerging markets debt in the halcyon days of 1993 got out of the market more quickly than they had got into it, and the primary source of demand which had buoyed the market throughout 1993 was suddenly mostly gone.[24]
The Chiapas uprising in 1994 underlined the political uncertainty of the region. Political risk in international finance usually refers to the risks associated with the stability of government and governmental decisions. In Mexico political risk also had a more literal meaning: 1994 was an election year and in March the ruling party’s presidential candidate, Luis Donaldo Colosio, was assassinated.[25]
In Brazil, 1994 was also an election year and early polls showed a populist left-leaning candidate in the lead.[26] The spectre of a retreat from economic austerity and the threat of a return to hyperinflation shook the market. Furthermore, a radical new economic plan, and a new currency, the Real, were introduced in July.[27]
In Venezuela, the banking system went into crisis and the government responded with a bailout which cost some 10 percent of GDP. Venezuela’s economy was in dire straits and default on its Brady bonds was a real and imminent prospect.[28]
Finally, to cap off a year which thrust political risk before investors without respite, in September there was a second assassination in Mexico, of the secretary general of the ruling party, Francisco Ruiz Massieu.[29]
By early December, most emerging markets debt traders were consoling themselves with the thought that at least things could not be worse in the market in 1995. They were wrong.
As 1994 drew to a close, Mexico was spending its foreign exchange reserves heavily to defend the value of the peso. These reserves, $30 billion in February, had declined to around $11 billion by December, 1994.[30] The overvalued national currency could no longer be supported and on December 19 the new Mexican government let the peso float against the dollar, resulting in a substantial devaluation.[31] In addition, the Mexican stock market fell over 40 percent in the first quarter of 1995,[32] and Mexican Brady bonds and eurobonds fell so far that at one stage dollar-denominated eurobonds issued by prime Mexican banks were yielding 2,500 basis points over U.S. Treasury bonds.[33] The common refrain of traders in January 1995 was that “it was almost a freefall ... I’ve never seen anything like it”.[34] This spoke to the general inexperience of the traders, as the market had been through it all before, in October 1991.[35] However, that crash was but a memory of the few “veterans” who had been in the market that long.
There are three major reasons the devaluation became necessary: (i) the previous administration had long left the peso overvalued to curb inflation;[36] (ii) Mexico’s short-term indebtedness had been growing so that it amounted to some 35 percent of its total debt, and its refinancing was proving increasingly difficult[37] as the many adverse factors at play in 1994 conspired to direct foreign capital away from Mexico; and (iii) over the preceding three years Mexico had accumulated a balance of payments deficit of over $90 billion, a deficit approaching that of the rest of Latin America and Asia combined, and was financing it by the sale of securities to U.S. investors, which throughout 1994 became increasingly difficult and expensive.[38]
Ironically, “commentators, economists and finance professionals had been calling out for a Mexican peso devaluation for some time”.[39] A crisis was caused by a development that the experts had been recommending but the inevitably of which the financial markets, replete from a year of profits, did not want to acknowledge. Indeed, even as late as November 1994 journalists were writing, “For Western investors the message is: buy ... the potential of most emerging markets [is] beyond doubt.”[40]
The Mexican peso crisis happened one month later.
The United States quickly assembled an international financial rescue package. Over $50 billion of credit support was provided for Mexico: $20 billion from the U.S. through its Exchange Stabilization Fund[41] and the balance from the I.M.F., the Bank for International Settlements, the Inter-American Development Bank, the World Bank and Canada.[42] This rescue package had a dramatic effect on the secondary market. On the day President Clinton announced the package Mexico’s par bonds rose from 44 cents to 55.5 cents and its discount bonds from 56 to 72.5 cents. The prices of other emerging nations’ debts rose likewise.[43]
Nonetheless, the flow-on effects of Mexico’s troubles were so severe that, even with time for reflection, financial journalists were writing that “Mexico had almost single-handedly destroyed the emerging markets as an investment class”.[44] How could one country almost destroy an entire market by itself? The answer was an effect named by someone who had overindulged in the oily indigenous alcohol of Mexico and paid the price.
Mexico’s problems in late 1994 and early 1995 were transmitted to other emerging markets with a speed and severity which few expected, and which was labelled the Tequila Effect.[45] The debt of almost all emerging markets, from Eastern Europe to Asia, was in the first months of 1995 affected by the Mexican devaluation and subsequent problems.[46] Argentina was the hardest hit, but the contagion spread through most of Latin America and Eastern Europe and much of Asia.[47]
Argentina suffered from capital flight “of staggering proportions” as “[m]uch of the flight capital that had returned to the country flew out again.” [48] In addition, “[s]hort-term capital, much of it American, stampeded out on fears of a return to hyper-inflation and a breakdown in ... dollar convertibility”.[49] This led to the collapse of a number of banks, and the government was soon seeking an international rescue package which when granted comprised some $11.4 billion.[50] In Thailand the baht came under sustained pressure and required massive support from the central bank to avoid a devaluation. Polish Brady bonds fell 7.8 percent and Bulgaria’s over 10 percent, the Philippines stock market fell over 17 percent, Hong Kong’s some 15 percent and the stock markets of nations as diverse as China, Hungary, India, Pakistan, Peru, South Korea, Taiwan, and Turkey all fell over 10 percent in January as funds withdrew generally from emerging markets.[51] Most East Asian nations, in particular, worked hard to distinguish their economies from Mexico’s as their stock and bond markets took a battering.[52]
Yet the economies of these countries shared little in common with Mexico. Argentina and Hungary were identified as having large and growing current-account deficits but far less of their deficits were financed by short-term capital -- a crucial part of the Mexican equation.[53] In part the tequila effect arose because many fund managers had invested heavily in Mexico and less so in the other emerging markets but, needing cash to meet margin calls and redemptions in Mexico, sold in the other markets.[54] Mostly, however, in the words of fund manager, Isabel Saltzman, “[i]t was the classic panic market”.[55] The tequila effect “was a sobering reminder that big institutional investors were looking at all ‘emerging markets’ from Santiago to Seoul through a single lens”.[56]
Recovery from the tequila effect took time.[57] Latin sovereigns were issuing debt, admittedly at very high spreads, as early as May, 1995[58] and bond issuers were active in the markets in the second half of 1995. However, Brady bonds traded at extraordinary yields throughout most of 1995. For instance, the stripped spreads (the spread after deduction of the collateral guarantees over that of comparable US Treasury bonds) for the Bradys of the major Latin nations exceeded 1,000 basis points for most of 1995 and, in October, still exceeded 1,250 basis points for Argentine Brady bonds.[59]
The peso crisis and tequila effect led to dramatic growth in asset securitisation throughout the region. Companies from Argentina, Brazil, Mexico and elsewhere raised funds through the securitisation of cash flows from export contracts for many products.[60] Asset securitisation proved to be an efficient and attractive way for emerging market entities to raise funds upon the credit risk of the contractual counterparty from a developed nation.
Prosperity and relative stability returned to the market in 1996 and these factors, coupled to the relatively low interest rates on offer, prompted debtors to seek to retire some of their Brady bonds and liberate the capital tied up in their collateral, and prompted a resurgence in syndicated lending to the emerging markets.
In April 1996 Mexico offered to exchange new 30-year global bonds for dollar-denominated Brady par and discount bonds. The exchange was structured as a modified Dutch auction and Mexico accepted offers for $1.75 billion of the new bonds at a spread of 552 basis points over U.S. Treasuries. This gave a yield of 12.4 percent.[61] The par bonds, which paid 6.25 percent, were exchanged for 67 cents on the dollar and the discount bonds, which paid Libor plus 13/16, at 80.6 cents.[62] This exchange resulted in the retirement of some $2.4 billion of Brady bonds.[63]
The exchange offer removed one of the enduring anomalies of the Brady bonds -- the amalgamation of U.S. and emerging market sovereign risk in the one instrument. This hybrid nature of Brady bonds always made them difficult to value and while the zero coupon bonds which provided a partial interest and principal guarantee could be stripped out (usually by shorting them) this was an expensive and inefficient process. In the words of Merrill Lynch,
“Brady bond structures were the result of complex negotiations between the restructuring countries and commercial bank advisory committees, with little consideration of their future marketability to traditional bond buyers. In the case of collateralized bonds, the result was a collection of inefficiently bundled attributes whose resulting value to most investors is lower than the all-in servicing cost to the issuer. ... Given the ... size of the Brady bond market, these structure choices are probably among the costlier marketing mistakes in bond history.”[64]
The Brady bond exchange appealed to Mexico for four reasons:
1. It allowed Mexico to access some of the collateral tied up in the Brady bonds. In the words of one Mexican finance ministry official: “It is inefficient to have $9 billion of our cash invested in US Treasuries when we can invest that money to cancel more expensive debt”.[65]
2. It reduced the stock of Mexican debt by $1.25 billion - there was some $600 million less of the new bonds because the Bradys were exchanged at discounts and the $650 million of zero coupon bonds used as collateral could now be used to retire short-term, and more expensive, debt.[66]
3. The new bonds established the long end of an extended, well-distributed, non-Brady yield curve for Mexican debt and proved there was investor appetite for 30-year non-collateralised Mexican risk.
4. Mexican officials claimed a further inducement of the exchange was to extend the tenor of their debt from 2019, when the Bradys were due to mature, to 2026.[67] As repayment of the Bradys was fully secured by zero-coupon bonds, this is a spurious factor although the exchange did, in facilitating the retirement of some $650 million of short-term debt, improve Mexico’s debt profile.
The exchange offer appealed principally to sophisticated institutional investors which already held Brady bonds but sought undiluted Mexican risk with higher yields.[68] There was very little participation by commercial banks and only around 24 percent of the issue went to Mexican banks.[69]
Somewhat extraordinarily, Mexico’s principal bankers for the past century and the architect of its Aztec and Brady bonds, JP Morgan, was not involved in this exchange which was managed by Goldman Sachs and co-managed by Salomon Brothers, Chase Manhattan and Deutsche Morgan Grenfell. The deal represented a real coup for Goldman Sachs, never before a noted emerging markets house.
As usual, Mexico’s initiative established a trend. In September 1996 the Philippines gave Brady bond holders the option of exchanging their 25-year collateralised Brady bonds for 20-year fixed rate uncollateralised bonds. The Philippines accepted $635 million of the Brady bonds, one-third of those outstanding, and $137 million in new money as the new bonds were also able to be acquired for cash.[70]
Brazil launched its Brady exchange in June 1997 issuing $3 billion of 30-year unsecured bonds priced at 395 basis points over U.S. Treasuries.[71] One-quarter of the new bonds were sold for cash and the balance, $2.25 billion, were swapped for some $2.7 billion of Brady bonds.[72] The exchange, arranged by Goldman Sachs and JP Morgan, liberated collateral worth $605 million.[73]
In September 1997, only weeks before the contagion from the Asian crisis spread through the emerging markets, Venezuela effected the largest exchange to date. It swapped $4.4 billion of Bradys for $3.68 billion of new 30-year bonds with a coupon of 9.25 percent and sold further new bonds for cash.[74] The exchange retired over one-half of Venezuela’s Brady bonds.[75] Argentina followed the leader, exchanging $1.75 billion of new unsecured 30-year bonds for its Brady bonds and Bocones, domestic dollar-denominated bonds, and selling a further $500 million of new bonds for cash.[76] Finally, Panama rounded out a hectic September, swapping $700 million of new 30-year bonds, at a spread only 250 basis points above U.S. Treasuries, for its Brady bonds. This was a quite remarkable transaction given that Panama’s Brady-style restructuring had only occurred in July 1996 and its Brady bonds were then issued at a 565 basis point spread over Treasuries.[77]
In mid-1991, John Reed, chairman of Citicorp, said that notwithstanding the need of developing countries for capital, the environment for cross-border lending was “inherently hostile” and would not change for at least a decade.[78] He was wrong. In 1990 there had been $14.9 billion of commercial bank loans to developing countries. The figure by 1996 was $36.5 billion and in 1997 there were $49.4 billion of commercial bank loans to developing countries.[79] The reasons for this re-emergence of lending to emerging markets are fourfold: (a) The peso crisis and tequila effect in 1995 made bond issuance difficult for many emerging markets debtors and the debtors actively sought loans. Indeed, for the first time since the debt crisis, in 1995 more capital was raised by loans than bonds;[80] (b) Asia accounted for most of the loans - only $25 billion of the total of $135 billion went to Latin America – and many of the loans were to private sector corporations and some were securitised by receivables;[81] (c) the commercial banks had been enjoying strong earnings for some time and were at peak liquidity; and (d) generally there was lots of capital in the system. [82] As always, capital flows to emerging markets are determined by liquidity in the developed nations - the demand is always there, it is the supply side that determines lending volumes.[83]
There were some significant differences between these loans and those of the 1970s.[84] The earlier loans were invariably unsecured. These loans are usually either secured in some way, or, if to a sovereign, for a specific income producing purpose. Security is most often attained by securitising receivables or structuring the loan as project finance. The days of financing the consolidated revenue of debtors are, thankfully, largely gone. Syndicated lending even survived the Asian crisis -- on April 1, 1998 the Export Import Bank of Thailand signed a $1 billion facility with 64 banks priced at 80 basis points over Libor, admittedly supported by a guarantee from the Asian Development Bank.[85]
Citibank was the first to establish a specialist trading desk for emerging markets loans in March, 1997. Other active institutions include Chase Manhattan, JP Morgan, ING Barings and Merrill Lynch. The difference between these and conventional emerging markets desks, which while principally dealing in bonds still do deal in loans, is that the new desks deal with syndicated loans made in the previous few years which trade at par and are performing – or, at least, which did and were until the Asian crisis.[86] As one would expect, the market was still thin and bid-offer spreads relatively wide at one-quarter to one-half a point.[87]
A new industry body, the Loan Syndications and Trading Association, was established in New York in late 1995 to promote and regulate secondary market trading in U.S. and European bank loans,[88] and the Loan Market Association was founded in London in 1996 to foster secondary market loan trading in Europe. Each association has devoted considerable attention to trading in emerging markets loans[89] which is interesting given the considerable overlap with EMTA’s work.[90] EMTA provided organisational and other technical support to the Loan Syndications and Trading Association in its early years.[91]
Accounts of this “emerging” secondary market in emerging markets loans make amusing reading. Articles written in 1997 with titles like “The newest game in town” present secondary loan trading and the problems in trading loans as opposed to bonds as if they were novel and not the daily fare of this market in the 1980s.[92] The financial markets have a radio-active memory, with a very short half-life.
Few predicted the economic crisis which commenced in Asia in 1997,[93] and almost no one predicted its severity.[94] Western capital had poured into emerging markets in record quantities in the preceding two years. Emerging markets stocks and bonds were being acquired by investors scornful of the low interest rates on offer in their home countries and fearful that the U.S. stock market had reached unsustainable heights.[95] The substantial risks which history as recent as 1995 taught were inherent in emerging markets instruments were simply not being factored into their pricing. This meant any generalised market scare was likely to have a major impact. It did.
The Asian problems began in Thailand in June 1997 and soon spread throughout the region. Nonetheless, it was not until October that the currency crisis, as it was then termed, deepened across the sector. Whether it is Wall Street in 1929 or 1987, or this secondary market in every year between 1991 and 1997,[96] October seems a bad month for financial markets. Perhaps this is due to the tendency of many trading accounts to begin to book the profits made that year in advance of the year end.[97] Whatever the cause, “beware the ides of October” should perhaps be tattooed on every fund managers’ and traders’ forearm: the major U.S. banks alone reportedly lost some $400 million trading in the emerging markets in October, 1997.[98]
The precipitating event this October was intense speculation on the Hong Kong dollar which, in turn, triggered a sustained plunge in Hong Kong share prices.[99] Once the contagion spread, it spread widely, to London and Wall Street and throughout the emerging markets.[100] Brazil’s Brady bonds fell in value 17 percent in the last ten days of October and leading Latin American mutual funds lost 17 to 20 percent of their value in a week.[101] It was as if Asia was retaliating for the tequila effect of 1995 by sending emerging markets globally into a tailspin,[102] and, just as in 1995, while the economic correlations between regions were weak, the psychological correlations were strong. Argentina, Brazil, Chile and Mexico were all affected with Brazil the hardest hit as it shared problems like a large current account deficit with the troubled Asian countries. Quick strong action by Brazilian authorities and prompt action by the authorities in the other countries, principally by tightening monetary and fiscal policies, restored market confidence and staunched the drain on foreign exchange reserves.[103] Accordingly, the contagion did not significantly damage the domestic economies of Latin American countries, or East European ones for that matter. That East Asia’s hangover did not spread to other emerging markets on anything like the scale of the Tequila Effect suggested a pleasing maturation in the secondary market.[104] Nonetheless, the shift in investor perception of the risk inherent in emerging market assets means that corporations and sovereigns from these nations are now paying substantially higher interest premia to raise capital.
The sell-off was so intense that many brokerages were overwhelmed and EMTA recommended that brokerages close 30 minutes earlier on October 29.[105] An indication of the volatility is given by the composite stripped spread on JP Morgan’s Emerging Market Bond Index which went from a pre-crisis 334 basis points on October 22 to 695 basis points by November 12.[106] Nonetheless, while a doubling in spreads is extreme, the October sell-off was, in part, merely correcting the anomalous and grossly excessive spread compression which had characterised the market since 1996.
The panic selling that had characterised the market in early 1995 was less prevalent in October, 1997.[107] This time the institutional investors showed the maturity and belief in the market that everyone wished they had shown two years earlier. Nonetheless, while many institutional investors did not dump large chunks of their portfolios in late 1997, neither did they return at all quickly to the market to increase their exposure to the sector.[108] While traders were pleased with, and somewhat proud of, this new-found maturity of the market’s principal investors, the market itself decayed quite severely in October, 1997. The error rate in matching trades was unacceptably high which delayed the settlement of many trades and bid-offer spreads widened dramatically to well over two percentage points.[109]
The crisis turned the clock back in the secondary market. As many of the most recent new investors left the market and spreads widened, the traditional emerging markets money returned.[110] Spreads of emerging markets bonds over comparable U.S. Treasury’s averaged 5 percent in March 1998, compared to 3.3 percent before the Asian troubles.[111] The Asian Crisis also turned back the clock further in other ways, back as far as 1982 in fact. Once again, once trouble broke, the international banks turned off the tap on new lending so decisively that a crisis became inevitable. The five most troubled Asian countries received $100 billion less in 1997 than in 1996, with South Korea alone receiving $50 billion less.[112] Many top U.S. corporations would struggle to survive such diminished access to debt financing; its impact on developing nations so drastic.
While poor prudential regulation in the debtor countries and misjudgments among creditors clearly contributed to the crisis, this was in no conventional sense a debt crisis.[113] It was initially a currency crisis[114] and developed into a more generalised economic crisis, at least for Indonesia, Thailand, and Korea, the three most severely affected countries.[115] However, while this was not a regional debt crisis, indebtedness did play a role in the troubles. The stock of debt in the region increased 12 percent in each of 1995 and 1996[116] and private commercial debt (debt not backed by a sovereign guarantee) increased a remarkable 50 percent from January, 1995 to December, 1996.[117]
Short-term indebtedness increased significantly in 1995 and 1996 across the region, although the increase was concentrated in China, Indonesia and Thailand.[118] The rapid increase in short-term debt in East Asia was not matched by Latin America, as seen in Figure One below – perhaps one of the few benefits of Mexico’s peso crisis and the Tequila effect. Indeed, it is likely that short-term debt flows to East Asia in 1995, 1996 and early 1997 were buoyed by Mexico’s troubles and the pall they cast over Latin America.[119]
Figure One -- 
The World Bank has concluded that, “[t]he buildup of short-term, unhedged debt left East Asian economies vulnerable to a sudden collapse of confidence ... The loss of confidence led to capital outflows, and thus to depreciating currencies and falling asset prices, which further strained private balance sheets and so proved self-fulfilling.”[120]
The buildup of short-term debt was not a region-wide phenomenon. The ratio of short-term debt to total debt in the countries of the region in mid-1997 ranged from 67 percent in Korea and 46 percent in Thailand, to 24 percent in Indonesia and 19 percent in the Philippines.[121]
The proliferation of investment in local currency local instruments definitely intensified the global contagion. The Asian Crisis began as a currency crisis and the decimation a substantial devaluation causes to a local currency portfolio naturally prompted a severe sell-off at the first sign of trouble. This was compounded by the tendency of many local currency local instruments to be of short duration for which, as the storm clouds gathered, the prospects of refinancing were slight.[122]
The big events in 1998 were the Russian repayment moratorium on foreign debt and devaluation of the rouble in August and the collapse of the major hedge fund, Long-Term Capital Management, in September. In Frederic Haller’s words,
“Last year [1998] was just about the worst that the emerging debt market has ever experienced. In particular, the Russian debacle in August ... was the defining moment of 1998”.[123]
In stark contrast to Asia the previous year, the contagion from Russia’s crisis was severe, far eclipsing the Tequila effect of 1995.[124]
By 1998 Russia’ economic and political problems had been mounting for some years. The radical reforms required to allow markets, not bureaucrats, to allocate resources were proving problematic for this former command economy burdened, as it was, with a deteriorating current account, tax collection problems, debt management problems, low oil prices, and industrial unrest.[125] In addition, there was considerable political instability arising principally from a sizeable bloc in parliament who sought to return the economy to the old system. Coupled to all this were the risk weightings under the Basel Capital Adequacy Accord which made loans to Russia attractive by weighting loans to OECD sovereigns at zero.[126] In the words of one senior banker, “your average loan commitment officer could hit his return on capital targets much easier offering money to Boris [Yeltsin] than he could lending to GECC”.[127]
In May 1998 declining investor confidence forced the Central Bank to raise interest rates to support the rouble. By July the central bank had been forced into extensive sales of its hard currency reserves to defend the rouble. In mid-August, 1998, the Russian Central Bank announced a widening of the band in which the rouble would be allowed to float. In effect this was a devaluation. In addition, the government declared a 90-day moratorium on the servicing of foreign debt by Russian firms.[128] Although most headlines at the time focussed upon the devaluation, the issue of vital concern to investors was the moratorium. Devaluations are a market risk, moratoria are a political one which in this case was seen as a policy choice to favour local banks over foreign investors.[129]
While Russia’s economic problems had been apparent for some considerable time, the market believed Russia would not be allowed to fail. In the words of Desmond Lachman: “Bulgaria didn’t fail. Thailand didn’t fail. Indonesia didn’t fail. But now Russia fails ... the IMF and the Group of Seven are no longer there as a backstop.”[130] In essence, the Russian crisis was a classic instance of moral hazard. Moral hazard occurs whenever a situation rewards investors for financial misbehaviour.[131] In the case of Russia, investors expected to be bailed out. In the words, again, of Desmond Lachman,
“Anybody who questions that Russia’s fundamentals were worthy of investment ... wasn’t operating in the markets at the time. ... Most [investors] who did take positions on Russia were doing this on the argument that Russia was too big to fail and that the G-7 nations would ... bail them out.”[132]
The proper operation of the market, which may have led to a more gradual withdrawal from investing in Russia, was profoundly affected by the moral hazard of an anticipated bail-out.[133] Russia’s geo-political signficance, in particular, meant investors were very confident that it would not be allowed to default on its financial obligations.[134] Indeed, even four months later, EMTA’s co-chair, Frederic Haller, was railing that, “The failure of the IMF and G-7 to show timely leadership in Russia in August may prove to be the biggest international policy mistake of the post-Cold War era.”[135]
The extraordinary aspect of Russia’s crisis was the fallout from it. Russia’s economy is not large, about the size of Spain’s or Switzerland’s.[136] Yet the consequences of Russia’s devaluation and moratorium were to stand the international bond markets on their heads.[137] In August, emerging markets debt fell over 28 percent in value, high-yield bonds fell over 7 percent, and real estate investment trusts that invested in mortgage securities fell about 27 percent. Meanwhile, U.S. Treasury bonds increased over 2 percent.[138] Russia’s collapse resulted in a tremendous flight to quality and this time investors went all the way to the security of US Treasuries. Even the bonds of the blue chip corporate sector offered insufficient security to bondholders in August and September, 1998.
How can one explain such profound effects from the events in one small to middling economic power? In part, the answer lies in the approaches to risk of the large investors, and this factor has three elements.
The first was an over reliance on the then new, sophisticated risk management techniques. Many funds and other investors, believing they could calculate their risk levels precisely, strove for yield and discounted risk as something that was now manageable.[139] However, contemporary risk management models assume a high level of liquidity[140] which history teaches us may not be there in times of crisis in the emerging markets and which was missing in August and September 1998.
The second element of the risk strategies of large investors was the common strategy of hedging against losses in emerging markets debt by going short US Treasuries[141] on the assumption that prices of emerging markets and US bonds historically moved in tandem.[142] The flight to quality that followed Russia’s collapse sent the yield on 30-year US Treasuries to the lowest levels since the US began issuing the bonds on a regular basis in 1977[143] while the yields on emerging markets bonds soared. As bond yield and price are inversely related, investors adopting this strategy found themselves long on emerging markets bonds which were falling in price rapidly and short US Treasuries which were increasing in price. As we shall see, this was a pincer sufficient to squeeze the capital out of even the biggest hedge funds.
The third element of the risk strategies of large investors was their appetite for leverage. Investors with highly leveraged positions in Russian assets were forced to sell other assets to cover margin calls or otherwise repay the debt incurred to invest in Russian debt. The other assets sold were most often, though not always,[144] in other emerging markets.[145] Accordingly, the continued appetite for leverage among many investors in the emerging markets means that a severe fall in one emerging market rebounds through the entire market, almost irrespective of the economic health of the other sectors.[146]
Another part of the reason Russia’s actions had such far-reaching consequences was that its heavy debt issuance had given it a high profile in the principal index. By spring of 1998 Russian debt accounted for one-seventh of JP Morgan’s Emerging Markets Bond Index Plus. A “neutral” investment position for an investor would therefore have seen it with one-seventh of its emerging markets portfolio in Russia. As The Economist pointed out, “This is a result of the perverse logic of bond indices. A country that has issued a lot of debt will be weighted heavily in the index, even though it may be borrowing its way into trouble”.[147]
The remarkable capital drain that followed Russia’s actions, exposed the continuing immaturity of the market as fund managers once again showed no significant ability to discriminate between emerging economies that had been successfully reformed and those which had not.[148]
The response to East Asia’s financial troubles and Russia’s devaluation and moratorium also highlights the extent to which the increased globalisation of financial markets has exposed the emerging markets to sudden and severe reversals in capital flows.[149]
Coming hard on the heels of Russia’s crisis, this collapse further rocked the market.[150] The collapse was caused principally by the hedge fund taking a huge position on the assumption that the already very wide spreads on emerging markets debt and high-yield bonds would return to their more customary levels. The fund went short US Treasury’s and long emerging markets bonds, high-yield bonds and European government bonds. As we have seen, the turmoil in Russia caused a flood of capital into US Treasuries and out of the emerging markets sector. Similar outflows from high-yield and European government bonds meant that the hedge fund got squeezed so hard its capital ran out.
The rescue package coordinated by the U.S. Federal Reserve required an effective $3.5 billion buyout of the fund by a consortium of banks and brokers.[151] For the hedge funds’ principal financiers, this was apparently a cheaper option than allowing it to fail.
The most significant event for the market in 1999 was Brazil allowing its currency, the real, to float in January.
Brazil’s Devaluation
Much like a fine wine, Brazil’s troubles had been a long time fermenting.[152] In November 1997 in the sell-off which followed East Asia’s troubles, Brazilian debt performed the worst of the major debtors, with the spread on its bonds widening by 453 basis points as against 405 basis points for Argentina and 262 for Mexico.[153] In the first half of September 1998 an extraordinary $14 billion departed the country’s foreign exchange market. The central bank lifted the basic lending rate to 49.75 percent on September 10, just one week after lifting it to 29.75 percent, and spent its foreign exchange reserves heavily to defend the value of the real.[154] In November, Brazil and the IMF reached agreement on $41 billion in aid to bolster the nation’s finances.[155] This package was specifically aimed at heading off a devaluation due to the fear such a prospect engendered in the wake of Russia’s troubles.
The real had been kept overvalued to combat inflation and to continue compliance with the real plan which called for a slow depreciation of the real of between 0.58 and 0.68 percent per month. The real had been introduced in 1994 and the real plan had succeeded in defeating the ruinous hyperinflation which had previously dogged Brazil.[156] The considerable commitment of politicians to it was therefore understandable.
However, by January 1999, Brazil could no longer afford to defend its currency: it had used over one-half of its foreign exchange reserves doing so in the previous six months and two weeks earlier one of its largest states had decided to withhold payments on debt to the Brazilian government. On January 15, the government let the currency float and it fell in value 17 percent against the US dollar in a week and about one-third in the first quarter of 1999.[157]
The fallout from Brazil’s devaluation was nothing like as severe as that from Russia’s devaluation and moratorium only five months earlier.[158] Argentine and Mexican assets suffered but not to the extent that many had feared.[159] Given that Brazilian debt has historically been the lynch pin of the secondary market, the reasons for this limited fallout are illuminating:
1. In light of the Russian debacle, investors had (a) reduced their exposure to emerging markets in general and to Brazil in particular as it had been showing signs of trouble since October 1997, and (b) reduced their leverage so that losses in Brazil did not force consequential asset sales to the same extent as in August.[160]
2. The central participants in Brazilian debt were the major international banks which had far deeper and more diversified portfolios than the hedge funds which had dominated investment into Russia.[161]
3. The moral hazard of an expected bail-out did not influence the market in Brazil. A $41.5 billion financial package had been put in place by the IMF in late 1998 and investors were adjusting their portfolios uninfluenced by the prospect of any further rescues. Indeed, Brazil’s abandonment of the Real had to some extent been anticipated.[162]
4. Floating the currency was welcomed by many in the financial markets which believed the real to be overvalued. In the words of Arturo Porzecanski, “This is what we’d been hoping for. The government had the courage to let the currency find its own level.”[163]
Encouragingly, after Brazil’s devaluation investors quickly differentiated between Latin American countries with sound economic fundamentals such as Argentina, Mexico, and Chile and those without, such as Brazil itself, Ecuador and Venezuela.[164] The lack of strong contagion across the region speaks to the increasing sophistication and maturity of the market. Indeed, if one could somehow ignore the sheer panic that Russia’s devaluation engendered, and simply focus upon the secondary market’s reaction to East Asia’s woes in 1997 and Brazil’s in 1999, one might well conclude that the market was approaching maturity. Pity about the fallout from Russia in which the market relapsed into its old bad habits of “looking at all ‘emerging markets’ from Santiago to Seoul through a single lens”.[165]
This period begins with the market coming out of the most rapid growth spurt in its history. Reported turnover for 1994 was $2.77 trillion face value of debt, an increase of some 40% over 1993 and nearly four times 1992 turnover. The brakes came on hard in 1995, with turnover stalled at $2.74 trillion. Rapid growth returned in 1996 with turnover nearly doubling to $5.3 trillion, and then rising slowly to $5.9 trillion in 1997. In 1998 the Asian and Russian crises asserted themselves and turnover fell some 29 percent to $4.2 trillion. In 1999 turnover was 2.185 trillion.[166] This turnover history is represented graphically as follows.
Figure Two[167]
Emerging markets debt represents a small part of the world’s capital markets. In September 1998, the capitalisation of JP Morgan’s Emerging Markets Bond Index (“EMBI”), the market standard, was $ 71 billion. The EMBI covers only U.S. dollar-denominated Brady bonds, and not the non-Brady bonds, local currency instruments and loans which comprise the balance of this market. Nonetheless, the total capitalisation of the emerging markets debt market would, on this basis, be about 2.2 trillion dollars[168] .
The market in this period traded five principal types of assets: Brady bonds, newly issued (non-Brady) bonds, local instruments, derivatives and loans. Local instruments are bonds denominated in either dollars or local currency, but issued in the local market, not internationally. The respective turnover of these types of assets in 1997 and 1998 is set forth below:
Table One – Turnover of Various Types of Emerging Markets Debt
Asset Type 1997 Turnover[169] 1998 Turnover[170] (Face Amounts in Billions of US $)
Brady Bonds 2,403 1,541
Non-Brady Bonds[171] 1,335 1,021
Local Instruments[172] 1,506 1,176
Debt Options and Warrants 365 233
Loans 305 213
The secondary market began its life as a swap market for loans, as virtually all the debt of the debt crisis of 1982 took the form of syndicated loans. As the market matured, swaps gave way to sales but loans remained the dominant form of debt throughout the 1980s.[173] The succession of Brady-style restructurings in the early 1990s saw many of these loans converted into Brady bonds: typically 30-year bonds with their principal and 12-18 months of interest payments collateralised by U.S. Treasury zero-coupon bonds.[174] Trading in Brady bonds in 1994 was up by 65% over 1993 and nearly seven times the turnover of loans.[175] The secondary market was, in essence now, a bond market, with Bradys representing 61% of market turnover. The transformation of what had begun as a loan market was by 1994 effectively complete with loans representing only 31 percent of turnover in 1999.
In early 1996 an enduring anomaly was removed as the ratings agencies removed the ratings distinction between a nation’s Brady bonds and Eurobonds. Eurobonds were newly issued bonds that did not arise from a restructuring of earlier indebtedness. Formerly, the agencies had rated Brady bonds one half a grade lower than Eurobonds arguing that debtors may turn to the holders of Brady bonds for relief in times of trouble more readily than to Eurobond holders as Bradys were the by-product of the bank loans of the 1980s. However, this prospect was determined to have diminished with the substantial sales of Brady bonds in the secondary market.[176] This begs the question why the yields of Bradys and Eurobonds did not also equalise, but they did not.
For a while the gap between the yield on newly issued bonds and the stripped yield on Brady bonds did narrow dramatically, from some 470 basis points in early 1996 to around 70 basis points in January 1998[177] - partly on the back of a wave of cross-over investment by investors who had concluded the risk on the two types of assets was essentially the same.[178] However, the gap soon widened again and by early July 1999 was around 420 basis points for the major debtors.[179]
Some argue these yield differences reflect a real credit distinction, i.e. that in troubled times debtors will honour their newly issued bonds more readily than their Brady bonds. This may have been true when the stock of global and euro bonds was so small that default on a nation’s Bradys and continued servicing of its global and euro bonds was a real possibility, just as most debtors did not reschedule their bonds in the 1980s because the stock of bonds was so small relative to loans. However, today the majority of bond debt of most of the major debtors is in the form of newly issued bonds, not Bradys, so defaulting on the latter while servicing the former would make no economic sense.[180] Potential reasons for this discrepancy in yields are as follows:[181]
(i) Stripping out the collateral, while easy to do on paper, is complex and difficult in practice and investors therefore are usually earning the blended yield which is lower than the yield on the global and euro bonds (because the yield on the collateral in the Bradys – US Treasury zero coupon bonds – is very low).
(ii) Brady bonds exhibit more secondary market volatility than global and euro bonds and so need to offer a higher return to investors.
(iii) Bradys tend to trade poorly in hard times as no bank is as committed to making two-way markets in them in the way that the arrangers of the global and euro bonds are committed to these issues.
With hindsight, 1994 represented the pinnacle for Brady bonds in this market. From accounting for 61 percent of turnover in 1994, the relative share of Brady bonds declined to 58 percent in 1995, 51 percent in 1996, 41 percent in 1997, 37 percent in 1998 and 31 percent in 1999, and by 2004 the proportion of turnover Brady bonds represented had fallen further to 6%.[182]
In each year from 1994 to 1999 Brazil’s was the most commonly traded debt, although by 1999 Mexico’s debt was also highly traded.[183] Brazilian debt accounted for 30 percent of turnover in 1997. In 1997 Argentine and Mexican assets filled the second and third spots with 21 and 17 percent of turnover, respectively. Fourth place went to Russian debt in 1997, displacing Venezuelan debt from 1996. 1998 saw Russian debt climb even further to second place with nearly 29 percent of turnover.[184] This capped five years of tremendous growth in Russian debt trading as Russian loans had represented only 1 1/4 percent of turnover in 1993. In 1999 the wheel turned full circle and Russian debt fall dramatically to represent only 5% percent of turnover.[185]
As can be seen, trading was concentrated in the debt of a small number of debtors throughout this period. Trading in the debt of Argentina, Brazil, Mexico, Russia and Venezuela represented over 90 percent of turnover in 1996, 85 percent in 1997 and 81 percent in 1998. Asian assets represented only 3 percent of turnover in 1996, 2 percent in 1997, and 4 percent in 1998 (although EMTA notes that, for a variety of reasons, Asian trading is under represented in its surveys).
Substantial increases in turnover came in local instruments in this period. The external trading of local instruments accounted for 19 percent of turnover in 1994 and rose steadily to 28 percent in 1998, and 33 percent in the first quarter of 1999. Local-currency denominated instruments outnumbered US dollar-denominated instruments by five to one in 1997 and seven to one in 1998. The importance of local instruments is exemplified by the fact that in 1998 trading in one local instrument, Mexican Cetes, at $164 billion, far surpassed trading in all of Mexico’s Brady bonds, at $96 billion.[186]
Another area of dramatic increase in this period was non-Brady bond trading, reflecting the dramatic increase in new issues in 1996 and 1997. These bonds, principally Eurobonds and global bonds, accounted for 29 percent of turnover in 1999, up from 24 percent of turnover in 1998, 11 percent in 1996 and 8 percent in 1995.[187]
The downturn in 1998 can be attributed to the meltdown in the Russian economy in August of that year and the continued uncertainty as to whether Brazil’s economy would be pulled into the maelstrom of the Asian and Russian economic crises.
The best way to appreciate the relative turnover of the various emerging markets instruments is graphically, as follows:
Figure Three: Turnover of Emerging Markets Debt, by Instrument, 1998[188]
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Before 1993, pricing an option in this market was principally a matter of ascertaining the level at which the seller was prepared to sell the debt,[189] and while pricing strategies increased dramatically in sophistication, derivatives continued to be used, in the main, by investors wishing to place a directional bet on the market.[190] Using options for this purpose became expensive in 1994 and 1995 as the cost of derivatives to investors is determined by the volatility of the underlying instrument and the market shocks of 1994 and 1995 caused sharp rises in volatility.[191] The increases in the cost of options caused investors to begin to use spread plays such as a bull spread which is the purchase of a call at one strike price and the sale of a call at a higher strike price which achieves some of the purposes of a straight option for less cost.[192]
The range of debt upon which derivatives could be acquired expanded in this period to embrace the likes of Venezuela, Poland, Morocco, Nigeria, Russia, Ecuador and Peru along with the major debtors.[193] Nonetheless the derivatives on offer remained simple relative to the sophistication of more mature markets with options and warrants dominating the market.
The market in derivatives on the currencies of these debtors was far more sophisticated and developed. In 1995 the Chicago Mercantile Exchange launched trading in Mexican peso futures and options and created a new division, the Growth and Emerging Markets division, to trade initially futures and options on Emerging Markets’ currencies, equities, interest rates and stock market indices.[194]
Derivatives specific to this market include those designed to strip out the zero coupon bond component of Brady bonds and sell the pure risk to investors. This was typically achieved by going short the zero but was difficult to do for most Brady bonds because the zero coupon bonds, issued specifically by the U.S. Treasury for the purpose, contained covenants designed to prevent this. Such derivatives were easy to structure for Brazilian Bradys, the zero coupon bonds for which Brazil had bought on the open market,[195] and derivatives specialists found ways to do it for the Bradys of Nigeria and Bulgaria, among others.[196]
In Chicago, the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBoT) actively developed their emerging markets derivatives business. The CME offered futures on, among other things, individual types of Brady bonds and emerging markets currencies and the CBoT offers futures and options on a Brady Bond index and various local stock market indices. Such derivatives trading is also conducted on exchanges in the emerging market nations, particularly Brazil and Mexico.
There is evidence to suggest that the availability and use of derivatives may have exacerbated the Asian and Russian crises.
In Asia, swaps were popular in which banks paid the return on U.S. instruments and received the return on domestic instruments. These swaps were off-balance-sheet transactions that could be funded on limited margins. The swaps were very profitable for as long as the relevant exchange rate held firm and resulted in huge losses once the local currencies depreciated dramatically.[197]
In Russia, the debt moratorium resulted in massive losses for foreign and local users of over-the-counter derivatives – losses which were as high as $90 billion on some estimates.[198] The attractiveness of Russian state short-term obligations (GKOs) to investors was enhanced by the use of forward contracts to hedge the investors’ rouble exposures. However, forward currency hedges do not protect against debt moratoria. In the World Bank’s words, “It is unlikely that investors would have assumed the same level of exposure to GKOs if derivatives had not been available.”[199]
Other characteristics of the market in this period were (i) extreme volatility, (ii) equity-like characteristics, and (iii) the high degree of correlation between geographic regions. The volatility came from the long term of the Brady bonds and the political and economic uncertainty in the debtor nations and was ensured by the short-term investment horizon of the principal types of investors in Brady bonds: trading houses taking large positions, highly leveraged hedge and Latin capital-flight funds and open-ended mutual funds concerned about redemptions.[200] The equity-like nature of these debt instruments and the correlation between regions takes a little more explaining.
Two pieces of research highlighted the equity-like nature of emerging markets debt in this period. The first was by Gary Evans and Jose Cerritelli,[201] and the second by Michael Pettis and Jared Gross.[202] Each argued that Brady bonds and emerging markets loans more often behave like equities than like traditional debt instruments. The preconditions for this behaviour were laid by the institutional structure of the market, the large issue size, long maturity and high liquidity of Brady bonds, and the political and economic uncertainty of the debtor nations.[203] Market behaviour certainly supports this thesis: (i) investors in emerging markets debt in bull runs received equity-like returns well in excess of equities in developed nations and often in excess of emerging markets equities;[204] (ii) the volatility of emerging markets debt, particularly upon developments in the debtor’s economy, resembled that of equity rather than debt; and (iii) investors used Brady bonds “as a macroeconomic equity play” on the debtor nations,[205] i.e., investors wishing to express a view on a nation’s prospects did so by buying or selling Brady bonds.[206]
The degree of correlation between various emerging equity markets was historically thought to be low. As King and Cox wrote, in 1995, “[a] familiar argument for investing in the 24 or so emerging markets has been that they are basically uncorrelated with each other, and so have comparatively low volatility as a global portfolio.”[207] In their article, King and Cox challenged this assumption for equities and proved correlation was increasing within regions such as Asia or Latin America and even between regions.[208]
Whatever may have been the historical position in equity markets,[209] emerging markets debt has always been highly correlated both within and between regions. In 1995 most investors viewed all of Latin America as a single market, and many viewed the entire emerging markets as one,[210] as the tequila effect established conclusively,[211] and the contagion which followed the economic crises in Asia in 1997 and Russia in 1998 confirmed. The 1997 contagion was less severe than in 1995, which suggested maturation in the market that the contagion from Russia’s crisis was to deny.
Much light can be shed upon the market by considering the factors which have driven it. The principal factors driving the market in this period were: (i) the increasing role of cross-over investors caused principally by the low yields available in developed countries coupled to stronger economic fundamentals in many emerging nations, (ii) the strong growth in new issues, (iii) the buy-backs of Brady bonds, and (iv) the tremendous increase in foreign investment in local instruments. In addition to these factors, the new Brady-style restructurings provided substantial impetus to the market early in the period.[212] Each factor will be considered.
Cross-over is the market’s term for mainstream institutional investors which add emerging market bonds to their portfolios for higher yield. They include pension funds, insurance companies, high-yield (junk bond) mutual funds, high-grade bond funds, international bond funds and hedge funds.[213] These funds control such vast amounts of capital that five percent of their portfolios far exceed the capitalisation of the specialist emerging markets funds -- and many allocate that proportion to the emerging markets.[214] The cross-over phenomenon is, in essence, the story of a broad array of money managers becoming comfortable with higher risk investments and learning to leaven their portfolio with a small proportion of higher risk assets in the quest for a higher overall return.[215]
The unprecedented inflows to mutual funds in the early-to-mid-1990s shrivelled fixed income yields in the developed countries. Cross-over investors moved further afield in search of higher yields.[216] They began to invest substantially in emerging markets bonds in the bull run of 1993 but fled the market when the bears growled in 1994 and 1995. They returned in far greater numbers in the bull run of 1996 and provided much of the impetus for the dramatic 39 percent increase in debt prices that year.[217] The returns were certainly there: in the first eight months of 1996 U.S. Treasuries returned negative 2.8 percent; U.S. corporate bonds, 0.6 percent; U.S. junk bonds, 6.3 percent; and emerging markets bonds, 15.7 percent. Cross-over investors also acquired much of the record $90 billion of new bond issues that year -- indeed, as 1996 progressed more and more underwriters began to sell new emerging markets issues from their high yield or high grade desks, rather than emerging markets desks, in recognition of the destination of the majority of the bonds.[218]
The flood of cross-over investment caused the yields on the traditional emerging market instruments, Brady and euro bonds, to fall sharply. The emerging market money that had brought these bonds to prominence moved on in search of higher yield, this time to local instruments - bonds denominated in either dollars or local currency, but issued in the local market, not internationally.[219] Local instruments developed into a major secondary market sector in this period.
By 1997, many cross-over investors had come to depend on the emerging markets to maintain above-average returns. The initial test of their commitment to the markets came in April 1997 as U.S. short-term interest rates began to climb. The prospect of a mass withdrawal by cross-over investors, as in 1994, led to a decidedly jittery market. Cross-over investors are traditionally strong on analysis of the issuers’ business and balance sheet and less so on analysis of country risk. However, in 1997 they displayed maturity and understanding of the market and did not withdraw en masse.[220] Indeed, cross-over investors underpinned the market until late 1997 as pension funds and insurance companies began to allocate from 3 to 6 percent of their portfolios to the emerging markets and follow the lead of the mutual funds which often were more heavily committed to emerging markets.[221]
With their perceived higher creditworthiness, East Asian and Eastern European issuers appealed in particular to cross-over investors.[222] Indeed, the flow of capital allowed yields to decline so dramatically that new issues by these issuers at around 100 basis points over U.S. Treasuries became common and Slovenia was able to issue a $325 million five-year eurobond at only 58 basis points over U.S. Treasuries[223] in an issue sold principally to mainstream institutional investors. Likewise, Indonesia was able to issue $400 million in ten-year Yankee bonds priced at 100 basis points over Treasuries.[224] As subsequent events confirmed, investors were severely underestimating the country risk.[225]
Cross-over investors brought the emerging markets into the investment mainstream. The most remarkable change in this period is that the secondary market moved from a specialist niche market to one simply one sector, albeit a risky sector, of the mainstream market.[226] This was borne out by the behaviour of the cross-over investors in the depths of the October 1997 sell-off. While many left the market, many more stayed, and cross-over investors displayed far more commitment to the sector than, for instance, did the hedge funds.[227]
In 1998, cross-over investors were again consistent buyers of the new issues.[228] However, not even the new-found commitment of the cross-over investors could withstand the contagion from the Russian crisis and many withdrew from participation in the market having suffered egregious losses. One factor which undermined the commitment of cross-over investors to the market was that most institutional investors did not benchmark their emerging markets bonds against an index as they would investment grade bonds.[229]
While this research does not deal in depth with new issues - neither eurobonds, yankee, samurai or dragon bonds[230] - the influence of the new issues on the market in this period is too large to ignore entirely. Yen and Deutsche mark denominated bond issues were the saviours of Latin American and Eastern European sovereigns in 1995 when nearly one-half of all emerging markets debt issues were denominated in one of these currencies.[231] Yields on Deutsche mark and yen bonds were very low and non-investment grade paper was rare in these markets. This allowed Latin American borrowers to raise massive amounts of funds at relatively fine prices.[232]
With the bull run of 1996, the issuers returned to the U.S. dollar, with 69 percent of bonds dollar-denominated,[233] and to issuing in record amounts: over $90 billion of bonds issued compared to $56 billion in 1995.[234] The largest issuers were Mexico with $17.8 billion of bonds issued, South Korea ($14.9 billion), Argentina ($11.7 billion), Brazil ($9.1 billion) and Indonesia ($4.8 billion).[235] Through 1996 and up to October 1997, tenors increased significantly and spreads narrowed dramatically.[236]
Mexico’s return to the voluntary capital markets on this scale signalled an astonishing rehabilitation from the peso crisis and tequila effect. Mexico’s officials received effusive and universal praise in the international capital markets for engineering Mexico’s return to pre-eminence among emerging markets borrowers.[237] As Tulio Vera said in mid-1996, “That an issuer, which less than a year and a half ago could conceivably default, can now go out and raise a 30-year bond is incredible”.[238]
There were a number of notable issues in 1996. Foremost among them was Mexico’s massive $6 billion debt issue in July which was used to repay the relatively expensive loans advanced by the U.S. Treasury as part of the U.S.-led bailout of Mexico in 1995.[239] JP Morgan managed the issue and creatively supported its credit with future Mexican oil revenues and by structuring it as a hybrid transaction in which purchasers could acquire either floating rate notes or certificated bank notes. The issue thus appealed to both bond investors and commercial banks.[240] Mexico had laid the groundwork for this issue with an innovative $1.5 billion issue in November, 1995 which yielded the higher of 12-month dollar Libor or 28-day Cetes yields minus 6 percent - Cetes are local market peso-denominated paper. This allowed investors to take a punt on receiving high returns while minimising risk for those funding in Libor.[241]
In 1997 notable issues included Argentina’s issue of ten-year eurobonds denominated in pesos. Priced at only 160 basis points over Argentina’s dollar-denominated eurobonds and issued in an amount of 500 million pesos, the issue confirmed the market’s faith in Argentina’s fixed peg of the peso to the U.S. dollar,[242] a faith that was to prove utterly misplaced.[243] The fluidity of these markets was well demonstrated by Mexico - it made a number of bond issues in the first half of the year in yen, lira, pounds sterling and dollars, and in August, 1997 used the proceeds to prepay the $6 billion 1996 issue thereby lengthening its debt maturity profile, securing lower interest rates and freeing up the oil revenue collateral attached to the earlier bond.[244] 1997 was also notable for the regular issuances by Latin American issuers in a broad range of European currencies and for regular global bond issuances of $1 billion and upwards, designed to ensure the liquidity which had often been lacking in the new issue market.[245]
The dramatic growth in new issues of 1996 was sustained through the setbacks of 1997 such as the U.S. Federal Reserve’s increase in interest rates in the first quarter and the onset of East Asia’s troubles in June.[246] The primary market displayed a depth and stability not seen before. The debtor nations, with Brady bond exchanges, global bonds, local debt programs and increased European currency issuance, likewise displayed a more sophisticated and flexible approach to liability management than in earlier years.[247] The growth in new issues in this period was supported by the improving economic outlook and liability management of debtor nations and driven by the low rates of return on investments in industrial countries, the increased liquidity in international capital markets and the increasing tolerance of risk displayed by traditionally conservative institutional investors.[248] October 1997 changed all this -- the demand for emerging markets debt largely evaporated but, fortunately, most emerging markets borrowers had all ready raised all the capital they needed for the year. The demand for dollar-denominated debt was the slowest in returning. For instance, in the first two months of 1998, Argentina raised the equivalent of $1.35 billion in the Deutschemark, euro/Ecu, French franc, guilder and lira markets, and only $500 million in dollars.[249] In early 1998, the Latin sovereigns principally raised capital in a host of European currencies[250] and Latin blue-chip corporates and major banks issued short-term dollar denominated paper.[251]
Notwithstanding its very real economic problems, Korea’s $4 billion global bond issue in early April, 1998 was three-times oversubscribed. The IMF’s record $57 billion bailout was in place, but such strong appetite for bonds yielding only around 350 basis points over comparable U.S. Treasuries was difficult to fathom.[252]
Russia’s crisis in August closed the market to new issues for a while and, recovery, when it came, was slow. For instance, 23 debt deals were completed in the primary market in November and the first half of December 1998 compared to 65 in the same period in 1997.[253] In the aftermath of Russia, most investors required extra inducements to buy bonds. So, for instance, Argentina was able to raise $1 billion in November, 1998 by issuing bonds with warrants that permitted holders to buy Argentina’s global bond due 2027 in one years time, at a fixed price.[254] The other popular inducement, along with warrants, was predictably the securitisation of assets such as oil and telecom revenues. The trend to sweeteners continued well into 1999 – for instance, in February Mexico’s $ 1 billion bond issue included warrants entitling the exchange in one year of Brady bonds into new global bonds,[255] and Argentina’s similar issue included warrants entitling the purchase of more of the same bonds in one year.[256] Inducements were necessary in 1999 for debt of maturities of five years and longer.[257]
The development in new issues in this period with potentially the greatest significance for the future was the trend towards issuance in emerging market currencies by the corporations and sovereigns of the respective countries and by the supranational institutions.[258] The supranationals followed this route partly because very fine pricing was achievable in these currencies in this period, and partly to develop the Euromarkets for currencies such as the Czech and Slovak korunas, Korean won, Mexican peso, New Taiwan dollar, Philippine peso, Polish zloty and South African rand.[259] The supranationals issued $4 billion equivalent in emerging markets currencies in the first nine months of 1997, four times the figure for the whole of 1996 and nearly eight times the amount issued in 1995.[260]
The trend towards local currency issuance in the Euromarket was significant, because it offered the best way to shift the exchange rate liability from debtors and onto foreign investors and thereby minimise the prospects of, and pain for debtors and creditors of, any future sovereign debt crisis.[261] When emerging markets debtors borrow in their own currency and their economy is healthy the real cost of such borrowing tends to be high, as interest rates are generally higher on local currency debt. When their economy is going badly the real cost of the borrowing tends to be low due to a deteriorating exchange rate. Raising capital in the relevant local currency tends to ensure that the debtors pay heavily when they can afford to, and less when they cannot. This is precisely the sort of liability profile to avert, or minimise the damage to all parties from, a debt crisis.[262] If the day arrives when a majority of sovereign borrowing by emerging markets countries is denominated in the currency of the debtor, the international financial system will be inherently far more stable and the risks of international debt raising will be apportioned far more equitably between creditors and debtors than was the case in 1982, 1995, 1997 or 1998.
The premise underlying the massive loans of the 1970s was that sovereigns never go bankrupt because they can always raise taxes; i.e. that the loans arranged by the economic elite of a nation can always be repaid by its poor. It required seven years of suffering by the poor of Latin America before the developed world began to embrace the notion of debt relief. Borrowing in local currency would reward creditors more highly when times are good, and have debt relief already built in, when times are bad.
Brady Bond exchanges are, of course, a type of buy-back and have been considered above.[263] They provided some impetus to the market in this period. Far greater impetus was provided by informal debt buy-backs which are an altogether quieter affair than exchanges. In an informal buy-back a sovereign repurchases its Brady bonds on the secondary market, typically using the proceeds of newly issued bonds. These repurchases are often conducted anonymously through agents so information on these buy-backs is scarce. The rationale for the buy-backs is as for the exchanges: the total stock of debt is reduced because the Bradys are repurchased at a discount and the liberated collateral is used to retire further debt. The trade-off is that the newly issued bonds are usually issued at higher interest rates and for shorter terms than the debt being retired and, of course, the principal has to be repaid upon maturity – it is not covered by zero coupon bonds as with Bradys.
Depending upon secondary market prices, and prevailing interest rates, buy-backs can be an extremely attractive proposition for debtor governments.[264]
Brady bonds typically did not prohibit buy-backs and, as bonds, had none of the sharing, parri passu and other clauses typical of sovereign loan agreements and of which waivers are needed for buy-backs to proceed.[265] Argentina, Brazil and Venezuela reportedly conducted substantial buy-back programmes in 1995.[266] Indeed, most debtors bought back some of their debt when prices fell far enough, partly to profit from the large discount and partly to provide stability for their paper -- when Brady bond prices fell, their yields increased, which meant higher yields had to be paid to issue new Eurobonds,[267] and emerging markets sovereigns retained a healthy appetite for Eurobonds.
Peru, rather cheekily, bought back substantial amounts of its debt while engaged in negotiations with its bankers for a Brady-style restructuring.[268] Peru reportedly bought some of its debt in late 1994 and early 1995 through Swiss Bank Corporation at prices between 42 and 52 cents[269] and a further $1.2 billion of its debt in July and August, 1995 for $600 million.[270] This was highly beneficial for Peru as past due interest was not usually forgiven in Brady deals and Peru was so far in arrears that past due interest and principal were roughly equal at around $4 billion each.[271] However, past due interest ceased to matter upon the repurchase and retirement of debt, so Peru was twice as well off by repurchasing its debt in the market than by restructuring it in a Brady-style restructure, even one with a principal discount as high as 50 percent.
Later deals included Argentina’s repurchase of some of its Brady bonds with part of the $1.7 billion from two yen and Deutschemark Eurobond issues in late 1995,[272] Mexico’s repurchase of $1.2 billion of Brady bonds at 81 cents on the dollar with the proceeds of a $1 billion twenty-year bond in September, 1996[273] and its redemption of $1 billion of Aztec bonds in March 1997,[274] and Poland’s repurchase of some $1.7 billion of Bradys in May, 1997. Numerous other nations, particularly Brazil, took advantage of the low interest rates in the primary markets to issue new bonds and use the proceeds to repurchase Brady bonds quietly in the secondary market.[275] These buy-backs were an important source of impetus on the market in this period, while at the same time diminishing the stock of the most liquid instrument in the market.[276] By late 1997, Brady bonds represented only 12 percent of the total stock of emerging market debt, and yet remained the most actively traded portion of the market.[277]
Informal Brady bond buy-backs continued throughout 1997, until the October market crash stopped the source of funds - the new issue pipeline.[278] However, while moving one group of debt repurchasers temporarily aside, the Asian troubles ushered another group onto centre stage. In Asia itself, the troubled corporations, or their principal shareholders, became major repurchasers of the corporation’s debt. At steep discounts, the repurchase of debt allowed the debtor corporations to obtain debt forgiveness and continue in business[279] - usually by virtue of capital injections from their controlling shareholders or by debt buy-backs by the shareholders.
As the effects of the Asian crisis contagion wore off in early 1998, the major Latin American nations apparently resumed repurchasing their debt.[280] Certainly by August and September of 1998 Argentina, Brazil and Venezuela were active in repurchasing their debt, with Argentina repurchasing some $700 million of its Brady par bonds in September alone.[281]
The emerging markets are driven by investors’ appetites for high yields and in 1993 this appetite led investors to debt instruments issued in the debtor country. The most accessible instruments were cetes (peso-denominated Mexican treasury bills), tesobonos (dollar-denominated Mexican treasury bills) and bonex (dollar-denominated Argentine treasury bills).[282] By mid-1994 nearly one-half of all cetes were held by foreigners.[283] By January 1995 foreign ownership had risen to 70 percent of cetes and 82 percent of tesobonos.[284] Indeed, it was the pending maturity of some $6 billion of cetes and $5.2 billion of tesobonos in late January and early February 1995 which helped trigger the peso crisis of December 1994 as it became increasingly unlikely that Mexico would be able to roll most of them over.[285]
It has been suggested that the movement into local currency bonds was supported by investors seeking debt instruments not linked to the dollar when U.S. interest rates were in decline.[286] Whatever the cause, the braver institutional investors were soon investing up to 10 percent of their portfolios into local instruments. The local instruments of the major debtors such as Mexico and Argentina attracted most attention but others, such as Polish zloty and Czech koruna instruments, and a growing range of Asian bonds, also attracted investors.[287] The high yields, particularly of the Latin American instruments, proved attractive to many investors as 1995 progressed.[288] These instruments were traded through the secondary market and added significantly to market volume.[289] As Table Two establishes, the secondary market was serving as the intermediary facilitating the flow of developed world capital to developing nations.[290]
Table Two: Turnover of Local Instruments [291]
(In billions of US$ face value of instruments).[292]
Year Turnover Share of Market
Local instruments are a substantial market sector with a total capitalisation of some US$850 billion at year-end 1996[293] and US$599 billion at year-end 1999.[294]
As the cross-over investors moved into the emerging markets, particularly the market in new issue bonds, and yields declined, the traditional emerging markets capital sought out higher returns in local markets. Stripped spreads on Brady bonds fell from 1900 basis points in early 1995 to 800 basis points in early 1996 and 400 basis points in early 1997.[295] Indeed, in one month alone in early 1997 spreads compressed by well over 100 basis points.[296] This spread compression was driven by the influx of cross-over investors into this market and the primary market. The compression squeezed many traditional investors out of the emerging markets, and, in turn, these traditional emerging markets investors supported a major expansion in local instruments.
As would be expected, the highest returns were earned in the most risky local markets such as Russia, Bulgaria, Romania, etc.[297] Russia, in particular, grew to rely upon short-term debt – much to its detriment.[298] GKOs, Russian sovereign short-term paper, represented 9.2 percent of public debt in 1994 and a remarkable 45.4 percent by 1996. By October 1997, outstanding GKOs totalled $55 billion with 30 percent held by foreigners. By December the proportion in foreign hands had declined to 18 percent due to the market sell-off in general and the withdrawal of Brazilian and Korean investors in particular.[299]
The major local currency index in this period was JP Morgan’s Emerging Local Markets Index which tracked local-currency money market instruments in twenty-four countries.[300] In addition, in 1997 Deutsche Morgan Grenfell commenced its Emerging Eastern Europe Index, which tracked performance of local currency local instruments in Eastern Europe.
An interesting variation in local markets was Mexico’s creation in 1997 of a local market in its internationally issued debt, both Brady bonds and eurobonds. Previously, a Mexican entity wishing to invest in these instruments had to convert their savings into dollars, deposit them outside the country and deal with a secondary market trader. Since 1997, an entity can acquire dollar-denominated Mexican sovereign bonds in Mexico for pesos, earn the interest in dollars and be paid it in pesos, and liquidate the position in pesos.[301] This provided much needed access for Mexican pension funds to diversified and long-term investments.[302]
The newly completed Brady-style restructurings in 1994-1995, predominantly of Brazil, but also of Bulgaria, the Dominican Republic, Ecuador, Jordan, and Poland each provided new bonds which traded far more frequently than did the loans they replaced and thus increased market activity.[303] These restructurings, particularly Brazil’s, brought significant amounts of highly liquid Brady bonds onto the secondary market and assisted in the market’s relatively quick recovery from the peso crisis and tequila effect.
This period saw a dramatic increase in sophistication of the practices of the market, starting, it must be said, from a relatively low base. The principal changes in market practices were the increasing use of live screens and brokers to trade the debt, the increasing importance of research, and four initiatives of the Emerging Markets Traders Association (EMTA): (a) limits on credit extended by traders to customers, (b) the multilateral netting facility, (c) Match-EM, and (d) the Emerging Markets Clearing Corporation. Each will be considered.
Live screens, quoting firm prices, became the norm for major assets in late 1993 and expanded in this period to include a wider range of debt. They proved highly efficient at disseminating Brady bond and Eurobond prices and “revolutionised Brady broking”.[304] In doing so they also changed the nature of trading. In 1994 and 1995 there was a distinct move towards screen-based trading through a broker and away from traders dealing directly with each other. As Jorge Jasson, of Chase Manhattan, said at the end of 1995,
“There’s not as much dealer-to-dealer trading now ... direct dealing is done mostly with clients. ... Our commitment to market-making and liquidity ... is to our clients and not to the Street. With more activity through brokers, professionals now are not required to make markets to each other.”[305]
This was a major change in the market’s operation. The market of the late 1980s and early 1990s functioned as an over-the-counter market, in which liquidity was provided by market makers buying and selling for their own account.[306] While the market remained, in essence, an over-the-counter market, the trend was towards its functioning more like an exchange, in which liquidity arose from brokers matching buyers and sellers, and less like an over-the-counter market.[307]
In early 1995, most traders were transacting about 50 to 60 percent of non-client business through brokers.[308] The increased use of brokers screens improved liquidity and price transparency. For the first time, live screens permitted traders to see the prices at which the market was clearing.[309] This increased use of brokers was promoted by the ease and efficiency of screen-based trading, and the broking commission war that had broken out.
In early 1994 the standard commission was two basis points charged to the party placing the buy or sell order (the so-called “aggressor”) and, shortly afterwards, 1 basis point to the aggressor. It appears this move towards fine commissions was an attempt by the major brokers to squeeze out some of the newer entrants in a market that was distinctly over-brokered. This substantial increase in the use of brokers was the only positive for brokers from a commission war that meant massive turnover was needed to earn profits broking Brady bonds.[310]
During this period institutional investors came to prominence in the market and their expectations also served to increase the sophistication of the market.
As institutional investors came to dominate this market they demanded high quality research upon which to base their investment decisions. JP Morgan began to increase its research effort in 1991 and by 1995 had 35 economists and analysts dedicated to emerging markets research.[311] In addition to the usual economic and political analysis, market strategy and forecasts, Morgan produced two indices: an Emerging Markets Bond Index and a Brady Bond Index. These indices appeared on most trading screens and the former, in particular, became a key tool for benchmark-focused investors.[312] To put Morgan’s research commitment into context, Chase Manhattan’s research team, itself highly regarded, at the time comprised 16 people.[313] Further evidence of the importance of quality research is demonstrated by the poaching in 1995 by Merrill Lynch of virtually the entire research team from Salomon Brothers.[314] Headed by Joyce Chang, the compact, but highly regarded, team of about 14 people gave Merrill an immediate profile in research.
The production of emerging markets research and indices served the market. The importance of a transparent market operating on high quality information is reflected in the decision of the International Finance Corporation to produce two indices of emerging markets equities.[315]
Nonetheless, relative to older markets, the market still operated on relatively poor information. This was reflected in the large number of traders who came from Latin American countries: in the absence of plentiful formal information, access to informal information sources, and a deep knowledge of a country, was relatively more important.
In 1994 the Emerging Markets Traders Association (EMTA) acknowledged that excessive leverage had contributed to the size and speed of the collapse of early 1994 and responded by recommending that the initial extension of credit by market participants to their customers be limited to between 50 and 75 percent for loans, 60 and 80 percent for Brady and other bonds, and 65 and 85 percent for short-term debt instruments.[316] EMTA’s guidelines and recommendations, which are still in force today, are not law and not directly enforceable. The experience of the market, though, suggests that the rate of compliance with them is high as sophisticated participants recognise their own interests in a well organised market.
In September 1994 EMTA implemented its Multilateral Netting Facility so that only the net trades would need to be reported to agent banks.[317] The netting facility reduced the administrative burden on the back offices both of traders and agent banks. In particular, the facility proved its worth on the restructuring of Russia’s debt in which it settled over $7.3 billion of when-issued, when-restructured and participation trades by 161 market participants in three weeks. Previously these settlements would have required many months to effect.[318]
Match-EM is an automated trade confirmation and matching system for Brady bonds and loans which allows traders to confirm trades almost instantaneously, thereby greatly reducing the risk of errors and other problems. It was launched on May 1, 1995 and within four months of commencement, about one-half of the market, and most brokers, were wired into it.[319] After one year of operation, there was a daily average of 1,200 trade inputs being entered into the system with an average matching rate of 92 percent.[320] Match-EM allowed EMTA to begin to collect and disseminate more accurate volume and price information on a daily basis, [321] and effected a substantial reduction in settlement risk. It also enabled participants to manage their inventories more effectively and enhanced the efficiency and transparency of the market.[322]
In early 1995 EMTA began developing proposals for a clearing corporation that would “accept matched trades of emerging markets debt ... , net aggregate trade positions and issue net delivery and payment instructions to Euroclear and Cedel.”[323] The Emerging Markets Clearing Corporation (EMCC) was established in conjunction with, and is operated by, the International Securities Clearing Corporation.[324]
The EMCC was primarily established to promote the efficiency and orderly development of the market and to end the over-concentration of counterparty risk in two sets of institutions: the commercial clearers of emerging debt (a field dominated by Daiwa Securities America), and the brokers. Rapid rises in market turnover led to increases in the number of Daiwa’s counterparties, exposing the firm to ever higher levels of counterparty risk. Likewise, higher turnover exposes brokers to a greater risk of having, unintentionally, to maintain positions overnight or longer and brokers are typically thinly capitalised. As all trades between members are guaranteed, and the EMCC is fully collateralised by all members, counterparty risk is massively reduced.[325] The impetus and guiding hand behind the formation of EMCC appears to have been that of JP Morgan motivated by its interest, as a major emerging markets trading house and as owner of Euroclear, in a more efficient market.[326]
The dramatic increase in Brady bond turnover that accompanied the October, 1997 market turmoil demonstrated in stark terms the need for such a clearing corporation. The ordinary turnover of about 750 Brady trades a day increased to 4,500 a day and the number, and rate, of mismatches increased dramatically. The EMCC could have provided real-time matching of trades and issued settlement instructions for both parties to Euroclear or Cedel -- thus avoiding the bottlenecks that developed in late October when mismatched settlement instructions became unacceptably common.[327] Unfortunately, as the market turmoil unfolded, the final proposal for the EMCC was at the Securities and Exchange Commission awaiting approval (which was not granted until February 1998). The EMCC commenced commercial operation in April 1998.[328]
There are costs to EMCC membership, as high-quality collateral has to be posted with the clearing corporation. Accordingly, many of the smaller banks and brokers did not join.
JP Morgan was the leading trader throughout this period. Its turnover was $1,052 million face value of debt in 1997, our sample year. Other prominent traders and their turnover in millions of dollars in 1997 are: Chase Manhattan ($810), Deutsche Morgan Grenfell ($790), Lehman Brothers ($600), ING Barings ($373), Bear Stearns ($335), Salomon Smith Barney ($257), and Bank of Boston ($259).[329] These figures are from surveys by Emerging Markets Investor. The figures appear somewhat inflated relative to other sources, as one would expect - they are self-reported. Nonetheless, the relative rankings of trading houses are probably accurate enough.
Deutsche Morgan Grenfell’s strong performance in 1997 is doubtless attributable to its bold hiring of over 70 of ING Barings sales, trading and research staff in mid-1996.[330] The dramatic move was at least in step with historical precedent: DMG acquired its entire, original Emerging Markets division of 50 staff in one swoop in 1990 when Libra Bank closed its doors. Major moves are not uncommon in this market. In March 1995, Bankers Trust’s 25-person emerging markets trading team moved to Donaldson Lufkin Jenrette - a complete newcomer to the business.[331] And in February 1998, ING Barings stopped all dedicated equities research, sales and trading for Latin America and laid off about 200 employees[332] - somewhat remarkable given that the bank had been voted the best overall emerging market bank, ahead of JP Morgan and Merrill Lynch, in surveys of some 1,500 money managers in 1997 and 1996, and their research team had been voted the best in the emerging markets only three months previously.[333] While it had a good debt trading operation, ING Barings had apparently been unable to establish a significant presence in the more lucrative corporate finance and equity underwriting sectors.[334]
By 1995 emerging markets divisions had become important parts of their respective banks. Citicorp’s experiences make this particularly clear. Between 1990 and 1994, Citicorp laid off or lost as a result of business sales some 19,000 staff, but in the same period added 6,000 new jobs in emerging markets.[335] By the end of 1994, 45 percent of Citicorp’s total profits came from its emerging markets operations, and the share was growing. This figure comprised the bank’s entire emerging markets operation, including corporate loans, bond and equity underwriting, equity trading, etc. in addition to the secondary market in debt. However, 45 percent of profits coming from emerging markets is nonetheless remarkable when one considers that, at the time, Citicorp was the largest bank in the U.S. and the largest issuer of credit cards in the world.[336]
Some indication of the number of traders in this market is given by membership of the Emerging Markets Traders Association. As of May 1, 1998 EMTA had 125 members which traded debt - 65 Full Members, defined as “institutions which actively trade Emerging Markets instruments”, a further 54 Associate Members, defined as “institutions that trade Emerging Markets instruments but are smaller and less active than Full Members”, and 6 Local Market Members, that trade in local instruments.[337]
The wave of cross-over investors began to alter the way the trading houses structured themselves. In mid-1997, Citibank merged its capital markets efforts in high-yield and emerging markets, while retaining separate sales desks, and Morgan Stanley merged its high-yield and emerging markets groups.[338]
The market turmoil in late 1997 and 1998 saw major staff reductions among the major banks and other trading houses in the final quarter of 1998. It was as if the major players were waiting to see if business would rebound after the Asian crisis and the Russian debacle convinced them it would not any time soon. The result was a slew of layoffs from banks’ emerging markets operations.[339]
Early in this period, the major net sellers of debt were the money-centre banks, particularly the Japanese and, to a lesser extent, the U.S. banks.[340] Their sales were facilitated, at least in the U.S., by loan-loss provisions that, by then, were generous. The major banks had deep pockets which remained well filled with Brady bonds[341] - in late 1994 Canadian and Italian banks had apparently not even begun to sell their Brady bonds and banks overall remained the largest holders of Brady bonds.[342] Indeed, these deep pockets posed problems for the market as more debt would come on to the market each time prices moved up, making a recovery difficult to sustain.[343]
Later in the period, debt was supplied to the market by the full range of its holders. Banks and investors from across the globe were now participating as sellers. The Asian and Russian crises, as one would expect, caused a wave of selling. Many open ended mutual funds were forced to liquidate assets at virtually any price to meet investor redemptions. In addition, as the regional economies went into a tailspin many local investors were forced to sell assets to stay solvent.
In this period, the investment vehicle of choice for retail investors were funds, and there was a full range available: emerging markets mutual funds (both open-ended and closed-ended funds), emerging markets infrastructure funds, emerging markets bond funds, emerging markets equity funds (some of which also purchased Brady bonds because of their equity-like characteristics); and the whole range of non-dedicated mutual funds which often invested a small portion of their capital into the emerging markets in search of a higher average yield.[344] Brady bonds were available from some brokers but generally in minimum denominations of $250,000; mutual funds were the preferred method of spreading the risk.[345] In addition, high-yield (‘junk”) bond funds often invested sizeable proportions of their portfolios, at times up to 25 percent, into emerging markets debt.[346]
There was a boom in funds in the first half of 1994 with over $8 billion raised by 211 funds.[347] Given the problems in the market, this was somewhat surprising, but it seems investors were hoping to recapture the 70 percent return most funds showed in 1993.[348] However, the peso devaluation and tequila effect in early 1995, reigned in this growth dramatically and only $1.33 billion was raised by 74 funds in the first half of 1995.[349] Bond funds enjoyed a good year in 1995, gaining on average 20.1 percent on the back of the high interest rates emerging markets issuers were forced to offer. On the other hand, equity funds, which far outnumbered bond funds, lost on average 4.6 percent for the year and Latin American equity funds were down on average 20.6 percent.[350] Nonetheless, mutual funds in general became so influential in this period that commentators were writing of “a new phenomenon in Latin America where mutual fund managers, not bankers, can bring an economy to its knees”.[351] Indeed, by the end of this period, Charles Dallara, the managaing director of the Institute of International Finance was quoted as saying, “the debt flows to the emerging markets are going to come from ... pension funds and mutual funds, ... not from bank balance sheets”.[352] Funds had assumed a central role in international capital flows.
An open-ended fund (known as a unit trust in England) is obliged to redeem shares (or units) if requested by shareholders at the net asset value per share. This posed enormous problems for fund managers in early 1995. The peso crisis led to a rush of redemption requests to funds that were invested in essentially illiquid underlying assets. The resultant shake out among open-ended funds suggested that closed-ended funds (known as investment trusts in England and in which investors can sell their shares on the market but not demand their redemption by the fund) were a more suitable vehicle for investing in the highly volatile emerging markets. [353] Nonetheless, as capital for the emerging markets was scarce in the first half of 1995, open-ended funds accounted for two-thirds of funds launched, as they allowed the fund manager to start with a smallish fund and create new shares over time if demand improved.[354]
The other big buyers were the other institutional investors: hedge funds, insurance companies, and pension funds.[355] The term, hedge fund is, simply, “a broad catch-all for an incentive-based partnership”.[356] Indeed, the term hedge in the title is an historical misnomer[357] Today hedge funds are more likely to be using leverage, short positions and derivatives in search of greater profits, than to be cautiously hedging their risks.[358] The quest for high yields drew hedge funds almost inevitably to the emerging markets.[359]
The sea change in the approach of institutional investors, especially mutual funds, towards risk continued in this period. In the words of a contemporaneous report,
“Strategies once deemed to be on the wilder, forbidden shores of the business are being eagerly embraced by mainline institutional investors. The justification? Investing across markets that are out of step with one another enhances returns while reducing risk.”[360]
Mutual and hedge funds were major investors in Brady bonds in this period, and, as we have seen, the supposed low correlation between countries in a region and between regions, if true for equities, had never been true for Brady bonds. Nonetheless, funds had to hand a neat justification to invest in a range of Brady bonds -- and returns from Bradys were high enough to make a fund managers performance sparkle. The other attraction of Bradys was their denomination in U.S. dollars which, fund managers said repeatedly, meant there was no currency risk.[361] However, denominating the bulk of a nation’s borrowings in U.S. dollars merely transferred the currency risk to the borrower and made payment difficulties and an eventual restructuring more likely - so essentially the risk remained with the investor.[362]
One of the principal changes to the market in this period was that the universe of investors broadened tremendously, at least until the Asian economic crisis of mid-to-late 1997. Throughout 1996 and the first half of 1997 the market enjoyed the support of the investors with long-term investment horizons which it had craved for so long - investors such as multi-national corporations, pension funds, insurance companies and mutual funds - the so-called cross-over investors.[363] These were principally U.S. investors as European institutions had not yet developed the appetite for risk of their U.S. counterparts.[364]
These funds had access to tremendous amounts of capital. As the World Bank noted in late 1997, “the last few years have witnessed an increasing concentration of national savings in the hands of institutional investors”.[365] Returns on emerging markets debt ensured that, although small, the proportion of this money finding its way into emerging markets debt was increasing. JP Morgan’s Index, a total return index, put total returns for 1996 at 39 percent across the sector and showed Argentina returning 35 percent, Brazil 55 percent, Mexico 35 percent, Panama a staggering 85 percent and Venezuela 62 percent.[366] The average return for 1996 was 42 percent compared to 13.5 percent for high-yield “junk” bond funds and 4.7 percent for high-grade U.S. bonds.[367] Emerging market equity funds were another story, with many leading funds returning substantial losses for the year. Such stellar returns on debt, merely one year after the tequila effect, establish that a year is a long time in the emerging markets.
The other major type of buyer in this period was hedge funds. As private entities, hedge funds are not subject to reporting requirements, and statistics on them are sketchy at best: while the World Bank states there were 57 dedicated emerging market funds in 1997 with some $7.1 billion of assets,[368] the London-based fund monitor, Tass Management, believes there were 85 funds with some $12 billion in assets, and other estimates are of 130 funds controlling some $15 billion.[369] Likewise general funds were estimated to control anywhere from $145 to $300 billion of assets.[370]
After October 1997, the wider spreads brought back the traditional emerging markets investors to the mainstream Latin American and East Asian assets.[371] The very fine pre-October spreads had seen much traditional emerging markets capital move on, often into local currency denominated instruments,[372] in search of higher yields - yields that were , again, to be found in their traditional hunting ground. The principal buyers after the Asian crisis were the traditional emerging markets investors, who understood the risks (which includes buyers from the emerging markets nations themselves), and U.S. high-yield funds investing in specific industry sectors.[373]
Screens have offered the market a number of advantages including facilitating swifter and more accurate trading and the anonymous conduct of large-scale business.[374] Before screens, major trades often moved the market as it speculated on why that bank would make that trade. For instance, if a bank known to act regularly for a certain country made a large acquisition, other traders might take positions on the assumption it was repurchasing some of the country’s debt for it.[375]
Screens have significantly improved liquidity and transparency in the market and, of course, entrenched the role of brokers. In 1993 perhaps one-fourth of non-client business was put through brokers, by 1996 the proportion was three-fourths.[376]
Screens were pioneered by Reuters which posted prices and names of participants on information from Martin Quintin-Archard’s Intercapital. In 1993, Chapdelaine Securities introduced its own no-name-give-up screens to strong resistance from many traders who wanted name-disclosed broking to continue so they could know who was doing what. The major brokerages such as Cantor Fitzgerald, EuroBrokers, Tradition and Tullett & Tokyo soon followed suit. Initially, these proprietary screens were only made available to market-makers who would stand by their prices, and so many boutique investment houses and second and third tier banks, which had used Reuters public screens, were denied access. However, by 1996 access had broadened so that the criticism was now that the service was available to too wide an audience and there were allegations that screens were being supplied to institutional investors and to local players in emerging markets nations.[377]
Brokers and their screens came to dominate the trading of Brady bonds – by 1998 estimates were that up to 90 percent of Brady trading in the interdealer market was conducted through brokers’ screens.[378] Nonetheless the market remained overbrokered, with perhaps twice the necessary number of brokerages scrambling for the business.[379] The reason for the overbroking was simple -even at one basis point, the potential commissions were huge.
The final significant participant in the market was the international securities clearing systems. The two principal international clearing systems were, and continue to be, Euroclear and Cedel. Formed in 1968 and 1970, these two clearing systems and securities depositories serve as the traditional means by which to distribute, hold, clear and settle Eurobonds. Mexico’s Aztec bonds, issued in 1988, were the first Latin American securities to be held in quantity in the clearing systems. Mexico’s Brady bonds were distributed, held and settled through the clearing systems but not without difficulty. The two principal difficulties were: (i) the entire issue was printed in $1,000 denominations, and (ii) value-recovery-rights were attached to the bonds so that repayments increase upon oil prices reaching specified levels - these rights had to be detached from the bonds according to a pre-determined programme and, once detached, settlement involved delivery of both the bond and the rights. The lessons were duly learned from these clearing and settlement difficulties: the entire bond issue in the subsequent Brady-style restructurings was represented by one global certificate and the concept of value-recovery-rights was dropped.[380]
The clearing systems have proceeded to handle the distribution, settlement and subsequent trading of each of the Brady bond and new bond issuances together with an ever-increasing array of local instruments.[381]
Presently, settlement in the clearing systems is by book-entries. If there is a physical certificate for the underlying security, it is held, immobile, at a clearing system depositary. Settlement can be in any of over 30 currencies, irrespective of the denominated currency of the security, and “delivery” and payment are simultaneous. These two features reduce the risks inherent in the physical movement of security instruments and in delays between delivery and payment. By 1995, the standard settlement period for bonds had been reduced from seven days after trade (T+7) to three days after trade (T+3). The efficiency of these standard procedures increased market liquidity and attracted some foreign investors, particularly to local instruments, which would otherwise have been chary of domestic settlement risk.[382]
The market had three principal effects in this period. It facilitated (i) the growth in local currency denominated instruments, and (ii) the growth in formal Brady bond exchanges and other debt buy-backs; and (iii) it exerted considerable pressure on emerging markets’ governments to implement the “Washington consensus” on economic policy. Each will be considered.
The issuance and secondary market turnover of local currency denominated instruments increased dramatically in this period as traditional emerging markets investors were driven out of Brady and new issue bonds and into these instruments by the willingness of cross-over investors to accept low returns on Brady and new issue bonds. The secondary market, in introducing many investors to the asset class, facilitated the growth in new issues as well as secondary trading. Of course, with hindsight, whether the typically short tenor of most local currency instruments served the debtors is highly questionable.
Debtors repurchased substantial amounts of their Brady bonds in this period, and did so when, and because, the secondary market price represented a particularly good deal for them. In this period, formal Brady bond exchanges resulted in the replacement of over $13 billion of Brady bonds with some $10.6 billion of newly issued bonds. The substantial amount of collateral liberated in this process was used principally to retire relatively expensive short-term debt. These Brady exchanges allowed the debtor countries to establish yield curves out to 30 years and were generally considered to have been in the debtor’s interests. Most of the participants in these exchanges were institutional investors that sought the higher yields available on pure emerging markets risk. Few banks exchanged their bonds. As the market had facilitated the transfer of ownership of Brady bonds from the original bank holders to the institutional investors, the market indirectly facilitated these Brady exchanges.
If formal Brady bond exchanges served the debtor nations, informal buy-backs certainly did. Informal exchanges, being private and confidential, did not drive up the secondary market prices of a nation’s bonds as did the announcement of a formal Brady bond exchange. Accordingly, the debtor nation was able to recapture the entire secondary market discount for its benefit. Informal buy-backs were the principal source of debt relief for Latin American sovereigns and for East Asian corporates, in this period.
The international movement of private capital has exerted considerable economic ‘discipline’ on emerging market nations.[383] Institutional investors almost invariably subscribe to the “Washington consensus” on economic policy - which prescribes budget surpluses or small deficits, relatively high interest rates to maintain the value of the local currency, minimal government price regulation, reform and liberalisation of local financial systems, and privatisation of state-owned assets. If one believes that this is a recipe for economic health in emerging market countries then the market serves a salutary purpose -- emerging market governments can only depart from the formula at the cost of severe penalties as the institutional investors withdraw their funds and the cost of raising capital increases as accessibility to capital decreases.[384] Equally, of course, if one believes that this is a recipe for economic dislocation and impoverishment of the already poor, the market’s impact has hardly been positive.
In January 1994, the bulls of 1993 looked like they would run all the way from Mexico to Pamplona. In February they stopped at Wall Street - and frightened institutional investors returned their capital to developed countries. By September and October of 1994, mutual funds and others were returning to the emerging markets and the optimists were again getting most of the media coverage.[385] In December the Mexican peso was allowed to float, and sank. The effect on the other emerging markets was like a quart of tequila - the hangover was horrendous. On one view, the hangover never fully lifted - in early 1997 average spreads on Brady bonds (the margin between their yield and that of U.S. Treasury bonds) were around 480 basis points compared to 300 basis points in 1993.[386] This reflected a change in the investor base. The typical investors in 1991 and 1993 were short-term speculators motivated by capital gains,[387] so called “momentum” investors,[388] of whom many were driven from the market by the collapses which began and ended 1994. Yields then had to rise to attract investors who wanted to lend to these countries in the longer term.[389] In the words of EMTA’s 1996 volume survey, “To many, 1996 marked a year when the emerging markets took large strides toward becoming a mature marketplace; and Emerging Markets debt instruments became a legitimate, distinct asset class and an important part of the investment mainstream.”[390]
However, the flaw in 1996 was that investors were happy with returns which did not reflect the real risks inherent in emerging markets debt. As U.S. Treasury Secretary Robert Rubin identified in 1999, “excessive capital flows ... can be indicative of broader failures in transparency and risk management ... there is ... a need to address the weaknesses in risk assessment that contributed to the recent crisis”.[391] Certainly, in 1996 investors in this market were making major errors in risk assessment – errors that increased the flow of funds to Asia and thus compounded the eventual problems there.
One clear lesson from this research is that contemporary risk management models may work well when their assumptions apply but a liquid market is one critical assumption for these models and the secondary market did not provide the required levels of liquidity in times of crisis in the second half of the 1990s. Models developed for the major capital markets of the world cannot simply be applied to the secondary market for emerging markets debt as if it is a smaller version of the New York Stock Exchange – no matter how much traders might crave the spurious certainty and security such models offer.
Nonetheless, the emerging markets in this period grew to become an inextricable element of the global financial markets, as the Russian crisis of 1998 firmly established. The global shift of investment capital into institutional investors has put a premium on high yields. The competition between fund managers to attract the most capital to their fund, retain their jobs and improve their annual remuneration ensures that the search for yield will continue to characterize much capital market behaviour. And, as long as yield is pre-eminent, the emerging markets will remain a significant and integral part of the global financial markets.
[1] Professor, Faculty of Law, University of New South Wales, Australia; Program Leader “Enhancing Australia’s Security and Prosperity in the 21st Century”, a Research Network of Australia 21 (http://www.australia21.org.au). I would like to acknowledge the generous support of the Group of Thirty (the Consultative Group on International, Economic and Monetary Affairs, Inc), Washington, D.C., which funded the research for this paper. My thanks to Jason Chai, and Tina Hunter for their invaluable research assistance. The usual claim of responsibility applies. The views expressed are my own.
[2] The Transformative Potential of a Secondary Market: Emerging Markets Debt Trading from 1983 to 1989, 21 Fordham Int. L. J. 1152 (1998); and The Facilitation of the Brady Plan: Emerging Markets Debt Trading from 1989 to 1993, 21 Fordham Int. L. J. 1802 (1998).
[3] Reschedulings as the Groundwork for Secondary Markets in Sovereign Debt 26 Denver J. Int. L. P. 299 (1998); The Regulation of the Emerging Markets Loan Market, 30 Law and Policy in Int. Bus.47 (1998); The Law of Emerging Markets Loan Sales, 14 J Int. Banking L. 110 (1999); The Practice of Emerging Markets Loan Sales, 14 Journal of International Banking Law 151. (1999)
[4] Ross Buckley, The Facilitation of the Brady Plan: Emerging Markets Debt Trading from 1989 to 1993, 21 Fordham Int. L. J. 1802 (1998).
[5] Scott Weeks, Where euphoria ends, maturity begins in Latin bond market”, 60 Latin Finance, Sept 1994, 26.
[6] Weeks, Id. at 26. Other indices deliver slightly different figures: the LDCX, compiled by Finacor, which is an index of Brady bonds and value impaired loans, recorded a 26.6% drop between the peak in mid-January and the trough in mid-April, and JP Morgan’s Emerging Markets Bond Index, which is a total return index (so that it includes the high yields) of Brady bonds, recorded a drop for 1994 as a whole of only 17.3%: see Melvyn Westlake, Annus horribilis, 2 Emerging Markets Investor, Jan 1995, 14 at 15.
[7] Emerging-market debt -- Crash landing”, The Economist, April 30, 1994 (UK ed)-at 113
[8] Secondary Markets -- Hit by US rates”, 1018 IFR, Feb 19, 1994; and Preview of 1995 -- Waiting for the next bull market, 1061 IFR, Dec 17, 1994.
[9] Secondary Market -- Hit hard, 1055 IFR, Nov 5, 1994.
[10] Emerging-market debt -- Crash landing, The Economist, April 30, 1994(UK ed), 113
[11] The 413 basis points figure is from the JP Morgan Emerging Markets Bond Index -- Latin, cited in Latin America -- New issue blues, 1049 IFR, Sept 24, 1994.
[12] Id.
[13] Emerging-market debt -- Crash landing, The Economist, April 30, 1994 (UK ed), 113; and Weeks, supra.
[14] Richard S Teitelbaum, A First-Class Payoff From Third World Debt, Fortune, Feb 21, 1994, 28; and LDC markets -- Majors hang toug”, 1049 IFR, Sept 24, 1994.
[15] Dangerous to know? The Economist, Mar 12, 1994 (UK ed), 114.
[16] Richard Voorhees, Volatile Mix; Latin American credit market, 57 Latin Finance, May, 1994, 26: “in the LDC secondary debt market, a lot more leveraging was being done than hedging, and ... an across-the-board collapse ... attests to that”.
[17] Weeks, supra.
[18] LDC markets -- Majors hang tough, 1049 IFR, Sept 24, 1994.
[19] Weeks, supra.
[20] Weeks, Id.
[21] Weeks, supra.
[22] LDC markets -- Majors hang tough, 1049 IFR, Sept 24, 1994.
[23] Id.
[24] Id.
[25] Latin America -- New issue blurs, 1049 IFR Sept 24, 1994.
[26] Id.
[27] Id.
[28] Venezuela -- Still in the doldrums, 1042 IFR, Aug 6, 1994.
[29] Westlake, supra. at 15.
[30] Id.
[31] Bloomberg Business News, Mexico Floats Peso, Sees It Sink, Sun-Sentinel (Fort Lauderdale), Dec 23 1994, at D1. Mexico’s handling of its devaluation in late 1994 attracted criticism, particularly for its timing only one week before Christmas when many investment houses were short-staffed and winding up positions for the year. Sean Kennedy, South China Morning Post, April 25, 1995, 14; and Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995.
[32] Gordon Platt, Mexican Virus Fells Emerging Markets But Prognosis Good Among Healthiest, Journal of Commerce, May 4, 1995, 2A.
[33] Catherine Evans & Keith Mullin, Investors step back into the arena, 1101 IFR, Sept 30, 1995; and Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995.
[34] Tequila slammers, 1064 IFR, Jan 14, 1995.
[35] Ross Buckley, The Facilitation of the Brady Plan: Emerging Markets Debt Trading from 1989 to 1993, 21 Fordham Int. L. J. 1802 at 1856-1860 (1998).
[36] William C Melton, The fall of the peso; Four factors contributed to the grand collapse, Star Tribune (Minneapolis), Mar 13, 1995, at 3D.
[37] Id; and Brendan Murphy, Foreign help stemmed financial panic in Mexico. Can it now heal a suddenly wounded economy? The San Diego Union-Tribune, Feb 5, 1995, at G1.
[38] William Keegan, In my view: Pesos from Heaven Pose Problems on Earth, The Observer, Feb 5, 1995, 2.
[39] Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995. See also Anthony DePalma, Casualty of the Peso: Investor Confidence, The New York Times, Dec 27, 1994, at D1, col 3; and David E Sangar & Anthony DePalma, On Both Sides of the Border, Peso Ills Were Long Ignored, The New York Times, Jan 24, 1995, at A1, col 2.
[40] Paul Nuki, Jaguar economies leap forward”, Sunday Times, Nov 27, 1994. To be fair to journalists, they do sometimes write articles of remarkable prescience: see James K Glassman, The Emerging-Markets Frenzy Is Starting to Look Foolish, The Washington Post, Jan 21, 1994, at D1, published one week before the first collapse of 1994; and see also Robina Gibb, Third World danger signals: Fat fees and capital hunger are haunting the emerging markets, Sunday Telegraph, Nov 20, 1994, 6, and Economists Caution Mexico to Increase Savings Rate, Los Angeles Times, Nov 26, 1994, at D8, col 1.
[41] Melton, supra. On January 12, 1995 President Clinton requested approval of the U.S. Congress for $40 billion of loan guarantees to prevent Mexico from defaulting of its debt. However, this proved to be politically controversial in the U.S. and while Congress tried to decide, the President acted unilaterally by negotiating additional loans for Mexico from the IMF and the Bank for International Settlements and by committing $20 billion from the Exchange Stablization Fund of the U.S. Treasury to Mexico. This Fund in the U.S. Treasury was generally used to stablise the U.S. dollar in the currency markets -- its use for such a purpose by a President acting without explicit Congressional approval was legally questionable as well as controversial (see Russell D Covey, Adventures in the Zone of Twilight: Separation of Powers and National Economic Security in the Mexican Bailout 105 Yale L. J. (1996) 1311). Nonetheless, most of the debt had been repaid by Mexico by January, 1997: David E Sanger, Mexico Repays its Debt, The New York Times, Jan 19, 1997, at sect 4, p 2, col 2.
[42] “IDB Meeting: a sentiment booster”, 1076 IFR, April 8, 1995; and “Tequila hangover -- a year to forget”, 1112 IFR, Dec 16, 1995. The Bank for International Settlements made some $10 billion available which Mexico declined to use as it was available only by way of short-term loans.
[43] Tequila slammers, 1064 IFR, Jan 14, 1995.
[44] Agency borrower -- Nacional Financeria -- Kicking the tequila habit, 1112 IFR, Dec 16, 1995.
[45] Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995.
[46] Id. The Latin sub-index of the JP Morgan Brady Bond Index fell some 30% in the first half of 1995: Kilby, op cit. See also Mexican crisis triggers wave of selling in Asian currencies, South China Morning Post, Jan 13, 1995, 1.
[47] Equity and Privatisation -- Proceed with caution, 1124 IFR, Mar 16, 1996; and Investors step back into the arena, 1101 IFR, Sept 30, 1995.
[48] Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995.
[49] Bill Jamieson, South American Agenda: Latins learning the new discipline, Sunday Telegraph, April 9, 1995, 4.
[50] Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995.
[51] Tequila slammers, 1064 IFR, Jan 14, 1995; Stan Hinden, Global Investors Strike Up the Bond, The Washington Post, Jan 28, 1996; Platt, supra; Clifford German, Wary Investors are spoilt for choice in Asia, The Independent, Feb 25, 1995, 20; Floyd Norris, Mexican Shadow Falls on Emerging Markets, The New York Times, Feb 1, 1995, at D1, col 5; and Vikram Khanna, The ghost of Mexico still haunts Asian markets, Business Times (Singapore), Mar 23, 1995, 13.
[52] Philip Shenon, A Bad Week In the Asian Markets, Too, The New York Times, Jan 16, 1995, at D1, col 6; Mustafa Hassan, Mexico’s economic debacle reflects failure of US policy, Business Times (Malaysia), Jan 17, 1995, 6; Maggie Ford, Showing everyone that Indonesia is no Mexico, Business Times, Jan 26, 1995, 11; and Datuk Dr Noordin Sopiee, We are not going down Mexico way, New Straits Times, March 14, 1995, 15.
[53] Latin America in the fallout zone, The Economist, Jan 7, 1995, 59.
[54] Id.
[55] Hinden, supra. To put the panic in context - in 1993 Mexico had been admitted to the OECD (see Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995) and the Mexican economy was considered so stable and prosperous that it was widely expected that Mexican debt would shortly be awarded an investment grade rating: Murphy,supra.
[56] Khanna, supra. 13.
[57] Melvyn Westlake, Bradys need a little time, 2 Emerging Markets Investor, Oct 1995, 10; Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995; Melvyn Westlake, Happy days return, 2 Emerging Markets Investor, Oct 1995; and Equities - Poised to enter a new phase, 1129 IFR, April 20, 1996.
[58] Sovereign Borrowing - Picking and choosing”, 1101 IFR, Sept 30, 1995.
[59] Melvyn Westlake, Bradys need a little time, 2 Emerging Markets Investor, Oct 1995, 14. Argentina’s Brady bonds rallied some 70% between their March 9 nadir and the reelection of a fiscally austere government on May 9, but fell back later in the year: Kevin Muehring, Looking for a lasting relationship, Institutional Investor, July, 1995, 45.
[60] Investors step back into the arena, 1101 IFR, Sept 30, 1995.
[61] The coupon was 11.5% and an issue price of 92.93% resulted in a yield of 12.4%.
[62] The valuation of the Brady bonds generally ignored the Value Recovery Rights (which provided for a higher coupon if Mexico’s oil revenues rose above certain benchmarks) and Goldman Sachs, somewhat controversially, ascribed very little value to these rights even though, with high oil prices at the time, they were nearly in-the-money: see Melvyn Westlake, Bidding Bradys bye-bye, 3 Emerging Markets Investor, June 1996, 10 at 15, Emerging Market Debt: Mid-500 bp consensus emerges, 1130 IFR, April 27, 1996; and Mexican debt. Warranted, The Economist, (US ed) May 4, 1996, 75.
[63] The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 80.
[64] Merrill Lynch, Emerging Markets Debt Monthly, June 17, 1997, 37.
[65] Melvyn Westlake, Bidding Bradys bye-bye, 3 Emerging Markets Investor, June 1996, 10 at 13.
[66] Most innovative deal -- Adios Brady, 4 Emerging Markets Investor, Jan 1997, 21.
[67] Melvyn Westlake, Bidding Bradys bye-bye, 3 Emerging Markets Investor, June 1996, 10 at 12. See also Mexico Offers Brady Bond Swap, J. of Com., April 22, 1996, 9A.
[68] The appetite for pure sovereign risk had been established because the most liquid Bradys tended to be the non-collateralised ones such as Argentina’s FRBs and Brazil’s C bonds and, in Panama’s Brady-style restructuring earlier in 1996, a majority of creditors chose non-collateralised over collateralised bonds: see Paul Kilby, Pure exposure; Latin American Brady bond market, 78 Latin Finance, June 1996, 28.
[69] Emerging Market Bond -- United Mexican States, Redrawing the yield curve, 1164 IFR, Dec 21, 1996.
[70] Deals of the year: Sovereign bond deal of the year, 8 AsiaMoney, Feb 1997, 38; and Steven Irvine, No expense spared by JP Morgan on Brady, 330 Euromoney, Oct 1996, 18.
[71] See generally The year in review: LatinFinance’s Deal of the Year, 94 LatinFinance, Jan 1, 1998, 35.
[72] There was an incredible $16 billion of orders placed for the $750 million of bonds sold for cash, so buyers received less than 5% of their orders: Michael Bender, Brazil sells $3 billion in cash/swap deal, Investment Dealers’ Digest¸ June 9, 1997, 12.
[73] Bender,Id.; Many ways to swap a Brady, 4 Emerging Markets Investor, June 1997, 4; and Peter Truell, Brazilians Sell $3 Billion of Unsecured 30-year Debt, The New York Times, June 5, 1997, at D8, col 1.
[74] Venezuela Sells $4 Billion of 30-year Bonds, The New York Times, Sept 12, 1997, at D13, col 1; Venezuela blows barriers with $4 billion bond exchange, 519 Euroweek, Sept 12, 1997, 1; and Argentina, Venezuela to accelerate Brady demise, 518 Euroweek, Sept 5, 1997, 1. This exchange was expanded dramatically from its initial $1 billion: Venezuela to Sell Post-Brady Bonds, The New York Times, Sept 4, 1997, D-15, col 1; and Venezuela bids farewell to Bradys, 106 Global Investor, Oct 1997, 17.
[75] Venezuela’s was the largest unsecured sovereign global bond offering in history, exceeding Italy’s $3.5 billion issue in 1993.
[76] Argentina yields US$2.25 bn”, 1200 IFR, Sept 13, 1997.
[77] Thomas T Vogel Jr, Brady Bond Market Shrinks, in Boon for Latin Nations, Wall Street Journal, Sept 22, 1997, A-16, col 3.
[78] Reed: banks won’t lend to LDCs for a decade or longer, 885 IFR, July 6, 1991, 29.
[79] Global Development Finance 1998s supra at 46. [cf figure of $59 bn for Latin America alone given in David Swafford, “Debt Doldrums”, LatinFinance, May 1998, 43.]
[80] Emerging Market Debt - US$216 bn capital flows, 1117 IFR, Jan 27, 1996; and Mary Tobin, Syndicated Loans -- Back to the future? Not likely! 1124 IFR, March 16, 1996.
[81] Tobin, Id.
[82] Syndicated Loans: Back to the future? Not likely!, 1124 IFR, March 16, 1996; and David Swafford, Debt Doldrums, LatinFinance, May 1998, 43.
[83] Michael Pettis, The New Dance of the Millions, 41, 4 Challenge: The Magazine of Economic Affairs, July-August, 1998; and Ross Buckley, Six Lessons for Banking Regulators from the Asian Economic Crisis, in Weerasooria (ed), Perspectives on Banking, Finance & Credit Law (Sydney: Prospect Media) 51.
[84] See generally L Buchheit, Cross-Border Lending: What’s Different This Time?, 16 Northwestern J. Int L. & Bus., 44 (1995).
[85] Paul Farrow, Asian Borrowers, 1229 IFR, April 18, 1998.
[86] David Swafford, Debt Doldrums, LatinFinance, May 1998, 43.
[87] Peter Eavis, The newest game in town, 4 Emerging Markets Investor, July/Aug, 1997, 12.
[88] See generally Loan Syndications and Trading Association, Inc., Second Annual Loan Syndication and Trading Conference: The Changing Landscape of Liquidity, October 13, New York City.
[89] Peter Eavis, The newest game in town, 4 Emerging Markets Investor, July/Aug, 1997, 12.
[90] Ross Buckley, The Role and Potential of Self-Regulatory Organisations: The Emerging Markets Traders Association from 1990-2000, (2000) 6 Stan. J. L., Bus. Fin, 135.
[91] Emerging Markets Traders Association, Bulletin, 3rd Quarter, 1996, (No 3), 7.
[92] Peter Eavis, The newest game in town, 4 Emerging Markets Investor, July/Aug, 1997, 12, presents, as new, issues such as banks not selling from their own balance sheets and requiring traders to sell from their own portfolios, the difficulties of trading loans as opposed to bonds, the need for standardised documents, and the need for confidentiality so banks are not seen to be selling a customer’s paper. All of these issues characterised the secondary market in the 1980s before the loans were securitised into Brady bonds: see Ross Buckley, The Transformative Potential of a Secondary Market: Emerging Markets Debt Trading from 1983 to 1989, 21 Fordham Int. L. J. 1152 (April, 1998).
[93] Jennifer Hewitt, The Money Trap, The Sydney Morning Herald, March 21, 1998, sect 6, p1, col1.
[94] The Asian economic crisis has been described by the IMF as “one of the worst financial crises in the postwar period”: International Monetary Fund, World Economic Outlook, May 1998, at 5.
[95] Paul Blustein, “Investors Reconsider Big Emerging-Markets Bets”, The Washington Post, July 20, 1997, H-01.
[96] Merrill Lynch, Emerging Markets Debt Monthly, Sept 19, 1997, 4.
[97] Andrew Capon, Simion Romijn, Baring Asset Management, 108 Global Investor, Dec 1997 / Jan 1998, 30.
[98] Thor Valdmanis, Banks take $400 mn hit on emerging market”, USA Today, Nov 20, 1997, 1B.
[99] Peter Chan, Banks jittery over emerging market debt, South China Morning Post, Oct 29, 1997, 3.
[100] The New York Stock Exchange fell 7% on October 27 and this sent the emerging markets sprawling: Alison Warner, Re-emerging from a crisis; Asian currency effects on emerging debt market, 148 The Banker, April, 1998, 40.
[101] Scudder Latin America lost 17% of its value in the last week of October, Fidelity Latin America lost 18% and T Rowe Price International Latin America lost nearly 20%: Edward Wyatt, The Manic Market: An Investor’s Guide, The New York Times, Nov 2, 1997, 3-9, col 1. See also Timothy L O’Brien, The Market Turmoil: The Risks, The New York Times, Oct 31, 1997, at D1, col 5.
[102] Emerging-market debt. Tigers’ revenge, The Economist (US ed), Nov 1, 1997, 78.
[103] International Monetary Fund, World Economic Outlook, May 1998, at 17 & 66-67; and The World Bank, Global Development Finance 1998, Vol 1 (Washington, DC: World Bank, 1998) 42.
[104] As the IMF has written, “An interesting feature of the emerging market crisis of 1997-98 is that the effects of the Asian crisis on Latin America have been relatively limited”: IMF, World Economic Outlook, May 1, 1998.
[105] Timothy L O’Brien, The Market Turmoil: The Risks, The New York Times, Oct 31, 1997, at D1, col 5.
[106] Jim Sullivan, Rapid rebound in sentiment, 1223 IFR Latin America Regional Report, March 7, 1998, 8. See also Alison Warner, Re-emerging from a crisis; Asian currency effects on emerging debt market, 148 The Banker, April, 1998, 40.
[107] Latin pipeline empties as spreads crash in face of emerging debt market sell-off, 526 Euroweek, Oct 31, 1997, 7.
[108] Danielle Robinson, Crunch time for emerging markets, Euroweek, Jan 1998, 240.
[109] Andrew Capon & Julian Marshall, After the storm: Stephen Freidheim, Bankers Trust, 108 Global Investor, Dec 1997 / Jan 1998, 29.
[110] Danielle Robinson, Crunch time for emerging markets, Euroweek, Jan 1998, 240; and Jerry Edgerton, Rebounding Emerging Markets Bond Funds Offer Lofty Yields -- If You Can Handle the Risks, Money, May 1998, 42.
[111] Mary Beth Grover, Civil wars and bedbugs, 161 Forbes, March 9, 1998, 219.
[112] Edmund Andrews, Panicky Western financiers turned a problem into a crisis, The Sydney Morning Herald, Jan 1, 1998, 21.
[113] Debt crises are generally characterised by total debt to exports ratios of over 200 percent and debt service to exports ratios of over 20 percent. The respective ratios for East Asia and the Pacific were 99 percent and 12 percent in 1996. Regional averages can, of course, mislead and, within the region, Indonesia’s 1996 debt to exports ratio of 220 percent and its debt service to export ratio of 34 percent suggests a debt crisis for that country. (The World Bank, Global Development Finance 1997, Vol. 1 (Washington, DC: World Bank, 1997) 160 & 161). However, the debt to exports ratios of Korea, Malaysia, the Philippines and Thailand were all substantially lower than those of Argentina, Brazil and Mexico in 1996. Indeed, the debt to exports ratios for East Asia and the Pacific in 1997 was 103 percent, compared to Latin America’s average ratio of 193 percent: The World Bank, Global Development Finance 1998, vol 1 (Washington, DC: World Bank, 1998) 33, 124 & 128.
[114] See, for instance, Merrill Lynch, Emerging Markets Debt Trends, Sept 19, 1997, 19.
[115] Malaysia and the Philippines substantially less affected: International Monetary Fund, World Economic Outlook, May 1998, at 62.
[116] The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 160.
[117] World Bank, Id. at 160. See the comments of Dornbusch, in Rudi Dornbusch, The sunny side of crises, Journal of Commerce, Sept 15, 1997, 7A.
[118] The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 160.
[119] Ross Buckley, “An Oft-Ignored Perspective on the Asian Economic Crisis: The Role of Creditors and Investors”, 15 Banking and Finance Law Review (2000) 431.
[120] The World Bank, Global Development Finance 1998, Vol 1 (Washington, DC: World Bank, 1997) 31.
[121] World Bank, Id. at 35.
[122] Asian dominoes, 1215 IFR, Jan 10, 1998.
[123] Haller, IMF misled us, 6, 2 Emerging Markets Investor (Feb 1999) 1.
[124] For instance, in the primary market in November and the first half of December 1998, 23 debt deals and 3 equity deals were completed. In the same period in 1997 when the numbers were 65 and 28, respectively. See Kiss of Life, 6, 1 Emerging Markets Investor (Jan 1999) 10.
[125] Ray Barrell, Karen Dury, Dawn Holland, et al, Financial market contagion and the effects of the crises in East Asia, Russia and Latin America, 166 National Institute Economic Review, October 1998, 57; and Paul Farrow, A bear with a sore head, IFR Review of the Year 1998, 48.
[126] Hal S. Scott and Philip A Wellons, International Finance: Transactions, Policy and Regulation 236-8, (9th ed. Foundation Press) (2002).
[127] Roller-coaster ride is far from over, IFR Review of the Year 1998, 20.
[128] Ray Barrell, Karen Dury, Dawn Holland, et al, Financial market contagion and the effects of the crises in East Asia, Russia and Latin America, 166 National Institute Economic Review, October 1998, 57.
[129] Edmund Andrews, “International Business: Russia Is Caught in a Financial Quandary”, The New York Times, August 20, 1998, section D, pg 5, col 1.
[130] Desmond Lachman, head of emerging markets research at Salomon Smith Barney, quoted in Jonathon Fuerbringer, “On Exchanges Around the World, Declines Show No Sign of Bottom”, The New York Times, August 28, 1998, 12; and Jonathon Fuerbringer, “1998; A Year Emerging Markets Seem Synonymous With Anguish”, The New York Times, August 27, 1998, section D, p 1, col 4.
[131] See generally L Buchheit, Moral hazards and other delights, IFLR, April 1991, 10 at 11.
[132] IMF Economic Forum, Financial Markets: Coping with Turbulence, a forum at the IMF, Washington DC, December 1, 1998; http:www.imf.org/external/np/tr/1998/TR981201.HTM
[133] Timothy O’Brien, When Economic Bombs Drop, Risk Models Fail, The New York Times, October 4, 1998, s3, p4, c 4; and Splendid isolation no longer, 1246 IFR, Aug 15, 1998, 1.
[134] “Many [investors] refused to believe the United States and the International Monetary Fund would allow Russia to collapse until it actually happened.”: Jonathon Fuerbringer, After Russian Lesson, Bond Prices Remain Stable in Latest Crisis, The New York Times, Jan 14, 1999, sC, p1, c2.
[135] Quoted in EMTA, 1998 EMTA Annual Meeting, Bulletin, 1st Quarter, 1999, 1, and Haller, IMF misled us, 6 2 Emerging Markets Investor (Feb 1999), 1. The other view is that the IMF could not lend “into the jaws of a completely irrational monetary policy”, in the words of Eric Krause, cited in Apocalypse now?, 6 2 Emerging Markets Investor, (Feb 1999), 4.
[136] Emerging Markets, Weight Problem, The Economist (U.S. ed), Oct 31, 1998, 80.
[137] Gretchen Morgenson, The Markets: Shocks and Aftershocks, The Bear is Rampant in the Markets for Riskier Bonds, The New York Times, Sept 17, 1998, sC, p1, c2.
[138] Id. See also, Emma Clark, Russian Crisis Rocks US Bank Debt Mart, Hedge Funds Sell, Vol XXII No 35 Bank Letter, Aug 31, 1998, 1.
[139] Robert Clow, Back Basics, Institutional Investor, April 1999, 87.
[140] “Roller-coaster ride is far from over”, IFR Review of the Year 1998, 20.
[141] Gretchen Morgenson, “The Markets: Shocks and Aftershocks, The Bear is Rampant in the Markets for Riskier Bonds”, The New York Times, Sept 17, 1998, section C, pg 1, col 2.
[142] O’Brien, supra. [when bombs drop]
[143] Sharon King, Stocks and Bonds; Foreign Turmoil Drives Investors From Dow to Treasuries, The New York Times, August 21, 1998, sD, pg 5, c3; All-time low, 1247 IFR Aug 22, 1998, 9; and Lower still?, 1250 IFR, Sept 12, 1998, 12.
[144] Some hedge funds sold US bank debt to cover emerging markets losses: Emma Clark, Russian Crisis Rocks US Bank Debt Mart, Hedge Funds Sell, Vol XXII No 35 Bank Letter, Aug 31, 1998, 1.
[145] Yang Won-il, Raising Funds Overseas More Difficult; Russia’s Financial Meltdown Exacerbates Situation, The Korea Herald, Sept 10, 1998.
[146] See, for instance, Onelia Collazo, Latin Bond Drop Mires Region in Crisis, LatinFinance, Sept 1998, 14. Compare the argument of Mohammed El Erian that Bulgaria, Hungary, Poland, South Korea and Thailand and only lowly correlated with the other emerging markets: Barbara Wall, One Investor’s Delight May Be Another’s Nightmare; For Bondholders, Down May Not Be Up After All”, International Herald Tribune, Jan 30, 1999, 15.
[147] Emerging Markets, Weight Problem, The Economist (U.S. ed), Oct 31, 1998, 80.
[148] David Wernick, Riders on the Storm, LatinFinance, March 1, 1999, 70.
[149] International Monetary Fund, World Economic Outlook, May 1999, Part II, 4-6.
[150] Long-term sickness?, The Economist, October 3, 1998, 81 (U.S. ed).
[151] Gretchen Morgenson, Fallen Star: The Overview; Hedge Fund Bailout Rattles Investors and Markets, New York Times, Sept 25, 1998, section A, pg 1, col 2; and Gretchen Morgenson, Billion-Dollar Bettor, New York Times, October 2, 1998, section C, pg 1, col 2.
[152] Leon Lazaroff, The Debt Roulette, LatinFinance, Jan 1998 / Feb 1998, 23.
[153] Brady Bonds, Rapid rebound in sentiment, 1223 IFR, March 7, 1998.
[154] Ermina Karim, All eyes on Brazil, IFR World Bank Report, Oct, 1998, 189.
[155] Onelia Collazo, Of Dismissals and Resignations, LatinFinance, Dec 1998, 10.
[156] Gabriel Juan DeSanctis, “Fundamentals under fire”, IFR World Bank Report, Oct, 1998, 181.
[157] Tim Padgett, Brazil’s Big Bounce, Time (Aust ed), Jan 25, 1999, 34.
[158] In the words of the IMF, “Financial contagion from the Brazilian crisis has been limited”: International Monetary Fund, World Economic Outlook, May 1999, Part I, 1; and at 80.
[159] In the words of Tanya Azarchs, an analyst at Standard & Poor’s, in December 1998, “If Brazil devalues, the impact on the financial community would be bigger than when Russia simultaneously devalued and defaulted in August”: Wake me when it’s over, Emerging Markets Investor, (Dec, 1998 / Jan, 1999), 6. See also Asia: Risks and Uncertainties in 1999, 12, 17 Emerging Markets Debt Report, April 26, 1999, 1; and Alison Warner, Emerging into the shadows; debt market, 877, 149 The Banker, March 1, 1999, 22.
[160] International Monetary Fund, World Economic Outlook, May 1999, Part I, 71; Jonathon Fuerbringer, After Russian Lesson, Bond Prices Remain Stable in Latest Crisis, The New York Times, Jan 14, 1999, sC, p1, c2; and Timothy L O’Brien & Joseph Kahn, U.S. financial industry may already have fortified itself against the latest emerging-market crisis, The New York Times, Jan 14, 1999, sC, p8, c1.
[161] Fuerbringer, Id. The hedge funds that were active in Brazil had reduced their exposure since the events in Russia: O’Brien & Kahn, Id..
[162] International Monetary Fund, World Economic Outlook, May 1999, Part I, 71; Alison Warner, Emerging into the shadows; debt market, 877, 149 The Banker, March 1, 1999, 22; Timothy L O’Brien & Joseph Kahn, U.S. financial industry may already have fortified itself against the latest emerging-market crisis, The New York Times, Jan 14, 1999, sC, p8, c1.
[163] Cited in Jeremy Weintraub, Brazil floats Real, forecasts improve, 1266 IFR, Jan 16, 1999.
[164] For who is living if those two are gone?, West Merchant Bank Investment Review, Feb 3, 1999, 3.
[165] Khanna supra 13; and see text accompanying note 52 above.
[166] All of these figures are from: Emerging Markets Traders Association (EMTA), 1994 Debt Trading Volume Survey, May 1, 1995, and accompanying letter dated May 1, 1995 from Michael Chamberlin to Members of EMTA; EMTA, 1995 Debt Trading Volume Survey, May 1, 1996 at 1; EMTA, 1996 Debt Trading Volume Survey, March 17, 1997, EMTA, 1997 Debt Trading Volume Survey, Feb 25, 1998; EMTA, 1998 Debt Trading Volume Survey, Feb 22, 1999; EMTA, Debt Trading Volume Survey 1999, Feb 24, 2000.
[167] As is the custom in the industry, these figures are not adjusted for the significant amount of double-counting involved in their compilation. The figures come from the annual trading volume surveys of the market conducted by The Emerging Markets Traders Association (“EMTA”) (which is also the source for the reported custom in the industry). The figures are compiled by surveying regular participants in the market which involves an element of double-counting as a single piece of debt may well be counted in the turnover of its seller and purchaser. This in-built tendency to overestimation is commonplace in the trading volumes of major capital markets, so these figures serve quite well for comparative purposes. If one is interested in the net amount of debt which changed hands in the market, these figures should be discounted by a factor of about one-third. (See Ross Buckley, The Facilitation of the Brady Plan: Emerging Markets Debt Trading from 1989 to 1993, 21 Fordham Int. L. J. 1802 at 1987-77 (1998)). This adjustment, over time, has tended to bring EMTA’s figures into line with the estimates of market participants. A one-third discount suggests an actual turnover in 1994 of some $1.85 trillion face value of debt -- close to the Emerging Markets Investor survey which put market turnover at around $2 trillion: Melvyn Westlake, Shaken, not stirred, 2 Emerging Markets Investor, March 1995, 11. Firms surveyed by LatinFinance in its annual secondary market survey estimated turnover for 1994 at $2.47 trillion: Paul Kilby, Growing pains: debt market survives bumps and bruises on its way to maturity, 65 LatinFinance, March 1995, 60. A one-third discount to allow for double counting has also been proposed by others: see LDC Markets: Majors hang tough, 1049 IFR, Sept 24, 1994. See also Emerging Markets Trading Association, Emerging Markets Trading and Investment (2002) http://emta.org/ar2000/t_i.html.
[168] Id.
[169] Emerging Markets Traders Association, 1997 Debt Trading Volume Survey, Feb 25, 1998, 7.
[170] Emerging Markets Traders Association, 1998 Annual Debt Trading Volume Survey, Supplemental Analysis, Feb 22, 1999, 8.
[171] The non-Brady bonds turnover comprised $923 billion of sovereign bonds and $389 billion of corporate bonds: Emerging Markets Traders Association, 1997 Debt Trading Volume Survey, Supplemental Analysis, Feb 25, 1998, 9.
[172] The turnover of local instruments comprised $977 billion of local currency denominated instruments and $202 billion of US Dollar denominated instruments: ibid.
[173] Buckley, “The Transformative Potential of a Secondary Market: Emerging Markets Debt Trading from 1983 to 1989”, 21 Fordham International Law Journal 1152 (April, 1998).
[174] For a detailed analysis of the Brady Plan, see Buckley, “Turning Loans into Bonds: Lessons for East Asia from the Latin American Brady Plan,” (2004) Vol 1 No 1 Journal of Restructuring Finance 185.
[175] Emerging Markets Traders Association, “Emerging Markets Traders Association Survey: Trading Volume in Emerging Markets Debt Instruments Nears Record U.S.$ 2.8 Trillion in 1994”, Press Release, New York, May 8, 1995.
[176] Alison Warner, Poles ahead, 146 Banker, March 1996, 18.
[177] In January 1998, the Mexican global bond due 2026 offered a yield of 9.51 percent, while Mexican Brady par bonds due 2019 provided a stripped yield of 10.2 percent. Likewise, the Brazilian global bond due 2027, had a yield of 10.97 percent and its par bond, due three years earlier, a yield of 11.47 percent: Lucia Reboucas, Investors prefer global foreign debt bonds, Gazeta Mercantil Online, Jan 9, 1998.
[178] Melvyn Westlake, Storming Morgan, 4 Emerging Markets Investor, 21.
[179] At close of business on July 9, the stripped yield on Argentine par bonds due 2023 was 17.82%, compared to 13.76% for its bonds due 2027; Brazil’s par bonds due 2024 were yielding 18.65% on a stripped basis relative to 14.18% for its bonds due 2027, and Mexico’s pars due 2019 were yielding 14.51% as against 10.41% for its bonds due 2026: e-mail from Michael Pettis to author, July 12, 1999 (copy on file with author).
[180] The presence of the rolling interest guarantee gives debtors a 12 to 18 month breathing space and may make default a little more likely, as default might be seen as a way of accessing the value tied up in the collateral supporting that guarantee. However, I have not seen this factor cited as a cause of the yield differentials and it could hardly account for significant differentials.
[181] E-mail from Michael Pettis to author, July 12, 1999 (copy on file with author).
[182] Emerging Markets Traders Association, EMTA announces 2004 annnual emerging markets debt reading rises to US$4.645 trillion (2004) at http://www.emta.org/ndevelop/Press_Release_4Q_2004_Survey.pdf
[183] Emerging Markets Traders Association, EMTA bulletin, 2000 (2000), http://www.emta.org/bulletin/1qtr00.pdf
[184] However, in the fourth quarter of 1998, trading in Russian debt represented only 10 percent of total turnover, as its economic turmoil struck the market: EMTA, Debt Trading Volume Survey Fourth Quarter 1998, February 22, 1999 at 31. The third and fourth spots in 1998 went to Mexican and Argentine debt respectively.
[185] EMTA, Debt Trading Volume Survey First Quarter 2000 , 2000, No.1 at 9.
[186] Emerging Markets Traders Association, 1998 Debt Trading Volume Survey, Feb 22, 1999, 26.
[187] Indeed, in September 1997 when non-Brady bonds represented about one-half of the trading turnover of Brady bonds, the total outstanding of Brady and non-Brady bonds were about equal at $130-140 billion apiece: Merrill Lynch, Emerging Markets Debt Monthly, Sept 19, 1997, 1; see also Emerging Markets Traders Association, 2000 Annual Report (2000) at http://www.emta.org/ar2000/ar00.pdf
[188] Emerging Markets Traders Association, 1998 Annual Debt Trading Volume Survey Supplemental Analysis, February 22, 1999 at 8.
[189] Emerging market derivatives -- No longer emerging”, 1049 IFR, Sept 24, 1994.
[190] William Nightingale, Jack of all trades; the many uses of derivatives in the emerging markets, 62 LatinFinance, Nov 1994, S12; and Barrocas & Beston, supra.
[191] Weeks, supra.
[192] Nightingale, supra.
[193] Emerging market derivatives -- No longer emerging, 1049 IFR, Sept 24, 1994; and World Debt Tables, 1994--95, (Washington DC: The World Bank) at 32.
[194] George Gunsett, Merc Reaches for Fresh Terrain; ‘Emerging Markets’ Division Proposed, Chicago Tribune, Sept 22, 1995, 1; William Smith, Merc Forming New Division, Chicago Sun-Times, Sept 22, 1995, 43; and Merc Expands; Expanding Markets Division Gets OK, Chicago Tribune, Nov 3, 1995, 3.
[195] Buckley, Turning Loans into Bonds: Lessons for East Asia from the Latin American Brady Plan, Vol 1 No 1 Journal of Restructuring Finance 185.
[196] Rick Beston, New investors, new products; derivatives trading in Latin America, 82 LatinFinance, Nov 1996, 62. See also Tom Groefeldt, A credit to themselves, 4 Emerging Markets Investor, Sept, 1997, CR4; and Ronit Ghose, Right tools for the job, 4 Emerging Markets Investor, Sept 1997, CR9.
[197] World Bank, Global Development Finance, Analysis and Summary Tables, 1999 (Washington DC: The World Bank, 1999) 39-40.
[198] Id at 39.
[199] Id at 39.
[200] Kevin Muehring, Looking for a lasting relationship, Institutional Investor, July, 1995, 45.
[201] Emerging market debt -- LDC debt is equity, 1058 IFR, Nov 26, 1994.
[202] Michael Pettis and Jared Gross, What does it Mean to Say that Debt has Equity-like Returns? The Delta of Low Quality Debt, Capital Markets Strategies, June 1995.
[203] Gary Evans, Identity crisis, Emerging Markets Investor, February 1995, 45.
[204] Evans Id. At 45; and Emerging market debt -- LDC debt is equity, 1058 IFR, Nov 26, 1994.
[205] Emerging market debt -- LDC debt is equity, 1058 IFR, Nov 26 1994.
[206] Kevin Muehring, Looking for a lasting relationship, Institutional Investor, July, 1995, 45, quoting Peter Geraghty of ING: “Bradys are the vehicle through which you express a view on the emerging markets. Because they are so large and liquid, they’ve become the best proxy for hedging positions in other markets, such as Latin Eurobonds”; and even local equity markets, according to Michael Pettis. See e-mail from Michael Pettis to author, July 12, 1999 (copy on file with author), stating “investors see Brady bonds as alternative and equivalent to local stock markets”.
[207] Kenneth King & Paul Cox, Too close for comfort, 2 Emerging Markets Investor, March 1995, 44.
[208] King and Cox, Id at 44.
[209] The assertion that equity markets have been lowly correlated strikes this author as strange given the apparent correlation between equity and debt emerging markets and the experience in the debt markets; but as this work has not focussed on equity markets, I cannot disprove this proposition.
[210] Equities - Scuppered, 1063 IFR, Jan 7, 1995.
[211] When currency problems in Mexico cause a run on the Thai baht and stock exchange prices to fall in India, Indonesia, Hungary and Poland, one knows that economic fundamentals are playing a minor role in investors’ decisions.
[212] A potential further factor is the increase in creditworthiness of some debtor nations. As the credit rating of a debtor improved, so the range of potential investors in its debt increased. In particular, an investment grade rating was particularly significant as a number of insurance companies and pension funds are proscribed by their constituent documents or state regulations from investing in below investment-grade assets. Poland received an investment grade rating from one of the two major credit rating agencies in 1994 and Colombia’s debt was rated as being of investment grade in September, 1995. (See Emerging market debt -- Oversupply worries, 1084 IFR, June 3, 1995; David Scanlan, Colombia to obtain $225 million loan from group of banks, Star Tribune (Minneapolis), Oct 9, 1995, 8D; and Latin America review -Tequila hangover - a year to forget, 1112 IFR, Dec 16, 1995.) These improvements in creditworthiness provided some slight impetus to trading in the secondary market.
[213] Peter Eavis, The crossover factor, 4 Emerging Markets Investor, May 1997, 16 at 17; and “merging Markets Trends, 1167 IFR, Jan 25, 1997.
[214] For instance, the 182 SEC-registered high yield funds tracked by Lipper Analytical have about $70 billion in assets, compared to the $2 billion in assets of the 21 SEC-registered emerging markets bond funds: Eavis, Id..
[215] Keith Mullin, Yield: the opium of global investors, 1200 IFR, Sept 13, 1997.
[216] Crossing the line, 1151 IFR, Sept 21, 1996.
[217] Eavis supra at 16.
[218] Crossing over takes hold,1177 IFR, March 8, 1997. For instance, 85% of the $700 million bond issue by Grupo Televisa, a Mexican media company, in May 1996 was sold to cross-over investors: Crossing the line, 1151 IFR, Sept 21, 1996.
[219] Eastern Europe: Tidal wave of foreign finance, 1151 IFR, Sept 21, 1996.
[220] Merrill Lynch, Emerging Markets Debt Monthly, Dec 16, 1997, 7.
[221] Danielle Robinson, Crunch time for emerging markets, Euroweek, Jan 1998, 240.
[222] Latin America: Back with a vengeance, 1151 IFR, Sept 21, 1996.
[223] Eastern European Bond: A stunning debut, 1164 IFR, Dec 21, 1996.
[224] Sovereign bond deal of the year, 8 AsiaMoney, Feb 1997, 38.
[225] For instance, the Czech Export Bank was able to obtain a three-year $150 million revolving credit (syndicated loan) priced at a mere 12.5 basis points over Libor: Eastern Europe: Tidal wave of foreign finance, 1151 IFR, Sept 21, 1996.
[226] Emerging Markets Traders Association, Emerging Markets Traders Association 1996 Annual Report, 1.
[227] Making sense of a meltdown, 4 Emerging Markets Investor, Nov 1997, 4; and Merrill Lynch, Emerging Markets Debt Monthly, Dec 16, 1997, 7.
[228] Sovereigns lead new-issue renaissance, 1230 IFR, April 25, 1998.
[229] And as do dedicated emerging markets funds.
[230] While samurai bonds were far less significant than euroyen issues, a remarkable 50 percent of all samurai bond issuances in 1995 were by emerging markets issuers. The secondary market in new issue bonds is not as liquid as for Brady bonds because many investors buy Eurobonds to hold until maturity. See Hogg, op cit, Paul Kilby, Growing Pains: debt market survives bumps and bruises on its way to maturity, 65 LatinFinance, March 1995, 60; and Secondary Market – Open Season, 1025 IFR, Sept 4, 1994. For a description of these bonds, see Christopher Mailander, Financial Innovation, Domestic Regulation and the International Marketplace: Lessons on Meeting Globalization’s Challenge Drawn from the International Bond Market, 31 George Washington J. In. L. Econ. 341 at 342-343 (1998).
[231] “Latin issuers back in contention”, 1124 IFR, March 16, 1996. See also Alison Warner, “Poles Ahead”, Vol 146 No 841 Banker, March 1996, 18.
[232] In particular, Argentina, Brazil and Mexico tapped the yen market, with Uruguay, Colombia and Venezuela joining them in issuing in Deutsche marks: Tequila hangover -- a year to forget, 1112 IFR, Dec 16, 1995; and ,for instance, Mexico was able to issue Yen 100 billion in bonds at a spread nearly 200 basis points less than that at which it had issued a similar amount of US dollars just two weeks earlier: Investors step back into the arena, 1101 IFR, Sept 30, 1995.
[233] Compared to 58% in 1995: International Bond Issuance: A Banner Year, 4 Emerging Markets Investor, Jan 1997, 3.
[234] Prospect ‘97, 4 Emerging Markets Investor, Jan 1997, 14; and International Bond Issuance: A Banner Year”, 4 Emerging Markets Investor, Jan 1997, 3. Cf the slightly lower figures in The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 105.
[235] International Bond Issuance: A Banner Year, 4 Emerging Markets Investor, Jan 1997, 3.
[236] For instance, average weighted maturities of emerging markets bonds lengthened to 11.5 years (from 4.5 years in 1995): Danielle Robinson, Crunch time for emerging markets, Euroweek, Jan 1998, 240.
[237] Danielle Robinson, Mexico repays market’s faith, 493 Euroweek, March 14, 1997, LA 26.
[238] Brian Caplen, Best emerging markets borrowers: Mexico, 326 Euromoney, June 1996, 64.
[239] David E Sanger, Mexico Says It Will Repay $7 Billion to the U.S”, The New York Times, July 26, 1996, at D1, c5.
[240] Best Deals of ‘96: Mexico’s Maxi, 4 Emerging Markets Investor, Jan 1997, 21; and Michael Tangeman, Mexico Gets the Timing Right, Institutional Investor, Jan 1997, 116.
[241] A watershed deal, 3 Emerging Markets Investor, Feb 1996, 42.
[242] Vote of confidence, 4 Emerging Markets Investor, March 1997, 13. By June, 1997, when Argentina issued a five-year Europeso bond, the spread had halved to around 80 basis points: Danielle Robinson, New world for Latin sovereign debt, 517 Euroweek, Aug 29, 1997, 48.
[243] Ross Buckley, Do Cry for the Argentines: An Analysis of Their Crisis, (2003) 17 Bank. Fin. L.R. 373.
[244] Prepayment potpourri”, 4 Emerging Markets Investor, July/Aug 1997, 11.
[245] Danielle Robinson, New world for Latin sovereign debt, 517 Euroweek, Aug 29, 1997, 48.
[246] Compare to: Emerging Market Debt: Has the party ended?, 1181 IFR, May 3, 1997.
[247] Danielle Robinson, New world for Latin sovereign debt, 517 Euroweek, Aug 29, 1997, 48.
[248] The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 107.
[249] Prime corporates left out in the cold, 1223 IFR Latin America Regional Report, March 7, 1998, 8.
[250] Emerging markets sovereigns, principally Latin American, issued some $12 billion of bonds in the first quarter of 1998: Sovereigns lead new-issue renaissance, 1230 IFR, April 25, 1998.
[251] Keeping it short, 1217 IFR, Jan 24, 1998, 88.
[252] The bonds went 70% to the U.S., 20% to Europe, and 10% to Asia: “Relief over Korea”, 1228 IFR, April 11, 1998; and see Buyers rush Korean bond issue, The Sydney Morning Herald, April 10, 1998, 21; and Kenneth Gilpin, The Markets: Bonds; Investors Snap Up Korea Bonds in a Big Vote of Confidence, The New York Times, April 9, 1998, section D, pg 1, col 2.
[253] See Kiss of Life, 6 1 Emerging Markets Investor 10, (Jan 1999)
[254] The price was 93.3. The bond was trading at 85.5 when the warrants were issued and at around 84 in February 1999. See Jonathon Fuerbringer, Argentina Sells $1 Billion of 20-Year Bonds, The New York Times, Feb 18, 1999, sC, p11, c1.
[255] Global bonds contain warrants, 1269 IFR, Feb 6, 1999, 68; and Jeremy Weintraub, LatAm sovereigns seize moment of stability, 1269 IFR, Feb 6, 1999, 63.
[256] Jonathon Fuerbringer, Argentina Sells $1 Billion of 20-Year Bonds, The New York Times, Feb 18, 1999, sC, p11, c1; and Jeremy Weintraub, Latin bond markets breathe new life, 1271 IFR, Feb 20, 1999, 59.
[257] Jeremy Weintraub, Phoney yield curve masks sovereign funding costs, 1274 IFR, March 13, 1999, 52.
[258] Such as the World Bank, the European Investment Bank, the International Finance Corporation and the European Bank for Reconstruction and Development: Supranationals buoy emerging currencies, 1242 IFR, July 18, 1998.
[259] While the range of new currencies was impressive, the depth of issuance was not yet there -- three-fourths of the volume of new bonds issued in 1997 were denominated in US dollars: The World Bank, Global Development Finance 1998, Vol 1 (Washington, DC: World Bank, 1998) 111.
[260] Charles Olivier, Changing world for the supras, Euroweek, The Supranationals Supplement, Oct 1997, 4; A widening search for arbitrage, Euroweek, The Supranationals Supplement, Oct 1997, 11; and Peter Temple, Currencies a la mode, 4 Emerging Markets Investor, July/August 1997, 31.
[261] Michael Pettis, The New Dance of the Millions, 41, 4 Challenge: The Magazine of Economic Affairs, July-August, 1998.
[262] Id.
[263] See text accompanying n __ .
[264] Paul Kilby, Smoother sailing? Latin Brady investment market, 70 LatinFinance, Sept 1995, 34; and Michael Marray, Stealthy buyback, 317 Euromoney, Sept 1995, 24.
[265] Ross Buckley, Debt Exchanges Revisited: Lessons from Latin America for Eastern Europe=”, 18 Northwestern J. Int. L. Bus. 655 at 679-80 (Spring, 1998).
[266] Kilby, supra.
[267] “Countries are also learning that they must do what is necessary to support prices of their [Brady bonds] if they are to remain in a position to issue other securities on the international markets”: Weeks, supra., See also Kilby, supra.
[268] Marray, supra.
[269] Marray, supra., and see Philip J Power, Sovereign Debt: The Rise of the Secondary Market and Its Implications for Future Restructurings, 64 Ford. L. R., 1996, 2701 at 2757-2760.
[270] Kilby, supra.
[271] Marray, supra.
[272] Marray Id. at 13.
[273] The new issue was issued at 445 basis points over U.S. Treasuries: The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 80.
[274] This was a great deal for Mexico as the coupon on the Aztecs was substantially higher than on the debt with which they were replaced and, in addition, some $400 million of collateral was liberated. The bonds were redeemed at par. See Danielle Robinson,”, 493 Euroweek, March 14, 1997, LA26.
[275] Brazil sets $5bn shelf, prepared bond/Brady buyback, 495 Euroweek, March 27, 1997, 4. Brazil, in particular, engaged in extensive informal buy-backs of its bonds: Finance against poverty, 1200 IFR, Sept 13, 1997.
[276] Buy back stirred Brady bond market, Gazeta Mercantil Online, Jan 5, 1998.
[277] Danielle Robinson, New world for Latin sovereign debt, 517 Euroweek, Aug 29, 1997, 48.
[278] Changing face of debt, 4 Emerging Markets Investor, Oct 1997, 4.
[279] Melvyn Westlake, Asia’s new junkyard, 5 Emerging Markets Investor, Feb 1998, 15 at 17.
[280] Secondary market, 1266 IFR, Jan 16, 1999, 91.
[281] Jim Sullivan, Hope fades from Brady/global market, 1 IFR Latin America, Nov 2, 1998, 16.
[282] Will Goodhart, Getting to know the locals, Emerging Markets Investor, Jan 1995, 52 at 53; see also World Debt Tables, 1994--95, (Washington DC: The World Bank) at 13-14.
[283] Goodhart, Id.
[284] Latin America in the fallout zone, The Economist, Jan 7, 1995, 59.
[285] Id; and Thomas T Vogel, More pain seen for emerging-market bond buyers, The Orange Country Register, Jan 23, 1995, D-23.
[286] Goodhart, supra at 52.
[287] Goodhart, Id; and Ernie McCrary, The blossoming of Asia bonds, 2 Emerging Markets Investor, Nov 1995, 10. For an analysis of Russian local instruments, see Paul Hofheinz, In the beginning was the GKO, 2 Emerging Markets Investor, Nov 1995, 19.
[288] Stan Hinden, While Latin American stock funds sagged, bonds romped, The Houston Chronicle, Jan 29, 1996, 7.
[289] Asian bonds were the least actively traded in the secondary market, Latin American the most: see World Bank backs Asian bond market, 1088 IFR, July 1, 1995.
[290] Nicolas Rohatyn of JP Morgan is “personally ... extremely driven by the notion that ... to intermediate capital between the developing and developed markets ... is a fundamental good for the world”: quoted in Saul Hansell, At Morgan, New Markets and a Rohatyn Emerge, The New York Times, Feb 28, 1994, at D1, c3. See the effect on an emerging market such as Malaysia in: Jennifer Jacobs, Prospects for public listings bright: Official, Business Times (Malaysia), April 19, 1995, 5. Whether these flows are a good is a separate question beyond the scope of this work- on one view they support development in emerging nations and on the other they permit excessive indebtedness and lead directly to currency crises such as Mexico’s in December 1994 and the East Asian economic troubles of late.
[291] Emerging Markets Traders Association, 1995 Annual Report, at 8; Emerging Markets Traders Association, 1997 Debt Trading Volume Survey Supplemental Analysis, 10
[292] EMTA’s surveys almost certainly grossly underestimate the turnover of local instruments as the surveys do not capture the turnover of many of the local traders in the emerging market nations. For instance, trading in Brazil in Brazilian local instruments is massive and it is unlikely that these figures capture very much of this trading at all: an IFR article.
[293] Sara Kandler, “Local Currency Markets Offer Promise and Risk”, 10 Emerging Markets Debt Report, Feb 3, 1997.
[294] Emerging Markets Trading Association, 2000 Annual Report
[295] Kandler, Id.
[296] Merrill Lynch, Emerging Markets Debt Monthly, Feb 7, 1997, 4.
[297] Rob Spence, Softly, softly catchee yield, 4 Emerging Markets Investor, June 1997, 32.
[298] Joanna Hickey & Paul Farrow, It’s all up to the IMF, 1235 IFR, May 30, 1998.
[299] Paul Farrow, Rolling out domestic debt markets, 1220 IFR, Feb 14, 1998.
[300] Claude B Erb, Campbell R Harvey & Tadas E Viskanta, New Perspectives on Emerging Market Bonds, Journal of Portfolio Management, Winter, 1999, 83; and Nicholas Reynolds, Emerging debt markets show independence, South China Morning Post, July 6, 1996, 7.
[301] Baron Levin, Bolsa Boasts Brady Bonds, Business Mexico, July 1, 1997; and Mexico to Trade Bradys on Local Markets, 10 Emerging Markets Debt Report, April 21, 1997.
[302] While technically such bonds are local instruments as they trade on a local market, they are treated for our purposes as external debt.
[303] Brazil completed its long-awaited restructuring in April, 1994. Brazil completed its restructuring without IMF approval by securing a waiver of that term from the banks and acquiring the required zero coupon bonds from the market, rather than using zeroes specially issued for the purpose by the U.S. Treasury. In a sense therefore this was quite different to all of the preceding Brady restructurings. Jordan had completed its Brady-style restructuring in December 1993, Bulgaria in July 1994, the Dominican Republic in August 1994 and Poland in October 1994. Ecuador’s restructuring was completed in 1995 with a 45 percent principal discount for discount bonds, more favorable for the debtor than the 35 percent which had become the norm in Latin America, but consistent with Poland’s restructuring. (See Kenneth N Gilpin, Foreign Debt Mop-Up; After Refinancing Brazil, Banks Now Face Just a Few Small Bad International Loans, The New York Times, April 18, 1994, D-1, col 1; See “No IMF letter for Brazil”, 1022 IFR, March 19, 1994, 49; World Bank, World Debt Tables, 1994--95, (Washington DC: The World Bank) at 4-5 & 27-29 and see 68-75 for the detailed terms of each restructuring; Bulgaria - Brady deal assessed, 1029 IFR, May 7, 1995; The next generation, 1027 IFR, April 23, 1994; Richard Voorhees, Rejoining the fold; Ecuador becomes the latest Latin American nation to agree to a Brady debt reduction accord, 58 LatinFinance, June, 1994, 60.)
[304] Susan Hogg, Squeezed until the pips squeak, 2 Emerging Markets Investor, April 1995, 33 at 35.
[305] Emerging Market Asset Trading House - Chase Manhattan - The art of staying focused, 1112 IFR, Dec 16, 1995.
[306] Paul Kilby, Smoother sailing? Latin Brady investment market, 70 LatinFinance, Sept 1995, 34.
[307] Ross Buckley, The Regulation of the Emerging Markets Loan Market, 30 Law and Policy in Int Bus. 47 at 58-60 (Fall 1998).
[308] Hogg, supra at 35.
[309] Kilby, supra.
[310] Hogg, supra. at 35. In early 1995 there were seven brokers in New York and five in London, in a market in which most brokers thought four in New York and two in London would be a happy number: ibid. New York accounted for about 80% of emerging markets debt broking because of the predominance of Brady bonds and eurobonds: ibid.
[311] Keith Mullin, Emerging Markets research house -- Moving into a new dimension, 1061 IFR, Dec 17, 1994; and Mary Tobin, Latin American Debt Research House -- Maintaining its pre-eminence, 1112 IFR, Dec 16, 1995.
[312] Mullin, Id..
[313] Mary Tobin, supra.
[314] Latin American Debt Research House -- Merrill Lynch -- New kid on the block, 1164 IFR, Dec 21, 1996.
[315] King & Cox, supra. and Emerging Market Debt -- IIF changes focus, 1028 IFR, April 30, 1994.
[316] Emerging Markets Traders Association, Bulletin 1994 No. 3, July - Sept, 1994, 2-3.
[317] Chamberlin, EMTA offers multilateral netting facility IFLR, May 1996, 41. The netting facility was developed in response to the large backlog of unsettled trades which had developed from the continued high volume of loan trading: “Loan Trading Backlog”, Emerging Markets Traders Association, 1994 No 3 EMTA Bulletin (July-Sept, 1994) at 2.. By early November, 1995 the facility had settled 1,837 trades of Russian loans with a face value of about $4.6 billion, some $125 million face value of Panamanian loans and $55 million of Peruvian loans: Emerging Markets Traders Association, EMTA’s Multilateral Netting Facility Settles Outstanding Panama Loans, Press Release, New York, Nov 8, 1995. See also Emerging Markets Traders Association, 1994 Annual Report, at 9.
[318] Emerging Markets Traders Association, 1997 Annual Report, 2 & 5.
[319] Kilby, supra. See also EMTA -- Moving ahead, 1112 IFR, Dec 16, 1995.
[320] Emerging Markets Traders Association, 1995 Annual Report, at 13; and Michael Chamberlin, ÉMTA offers electronic matching for Brady bonds and loans, IFLR, June 1996, 48 at 50.
[321] Emerging Markets Traders Association, 1995 No 1 Bulletin, 1st Quarter 1995, at 6.
[322] Emerging Markets Traders Association, 1994 Annual Report, at 9.
[323] Michael Chamberlin, “EMTA offers electronic matching for Brady bonds and loans”, International Financial Law Review, June 1996, 48 at 50.
[324] Chris Kentouris, “Global Goals Drive DTC-NSCC Merger”, Securities Industry News, March 29, 1999, 1.
[325] “Enterprising EMTA”, 3 Emerging Markets Investor, Sept 1996, 7.
[326] For an excellent analysis of Morgan as the driving force behind the EMCC, see Jack Willoughby, Emerging risk, Institutional Investor, Dec 1997, 39.
[327] Willoughby, Id. At 39.
[328] The EMCC cost about $3.5 million to establish.
[329] Melvyn Westlake, Scrambling for the top, 5 Emerging Markets Investor, March, 1998, 17; and Melvyn Westlake, Storming Morgan, 4 Emerging Markets Investor, March, 1997, 21.
[330] Melvyn Westlake, DMG goes for broke, 3 Emerging Markets Investor, July-August, 1996, 16.
[331] Ernest McCrary, Rendezvous on Park Avenue, 3 Emerging Markets Investor, June 1996, 46.
[332] Patrick Weever & Richard Newton, Barings to suffer massive cutbacks, Sunday Telegraph, March 8, 1998, 1.
[333] Investors’ Number One: ING Barings romps home again, 4 Emerging Markets Investor, Sept 1997, 28; and Local Knowledge Is Power, 4 Emerging Markets Investor, Dec 1997, LB3.
[334] ING Barings axes 200, 1220 IFR, Feb 14, 1998, 4.
[335] Bank of the year -- Citicorp, 1061 IFR, Dec 17, 1994.
[336] Id.
[337] Emerging Markets Traders Association, 1997 Annual Report, 16.
[338] High-yield future, 1187 IFR, June 14, 1997.
[339] Richard Miles, Merrill Lynch to shed 3,400 staff, The Times¸ October 14, 1998; Onelia Collazo, Of Dismissals and Resignations, LatinFinance, Dec 1998, 10; and Ellen Leander, Next the big shake-out”, Emerging Markets Investor, Oct 1998, 11. For instance, in September Bankers Trust let go of 34 staff in Mexico and another 20 from the emerging markets desk in New York and in November Credit Suisse First Boston dismissed 45 from its emerging markets trading and derivatives desks: Collazo, ID.
[340] Paul Kilby, Smoother sailing? Latin Brady investment market, LatinFinance, Sept 1995, 34; and Norman Peagram, How safe are those Bradys”, Euromoney, Sept 1994, 50.
[341] Kilby Id.
[342] Norman Peagram, How safe are those Bradys?, Euromoney, Sept 1994, 50.
[343] Melvyn Westlake, Bradys need a little time, 2 Emerging Markets Investor, Oct 1995, 14.
[344] Melvyn Westlake, Shaken, not stirred, 2 Emerging Markets Investor, March 1995, 11 at 13; and Melvyn Westlake, Turning up the heat, 3 Emerging Markets Investor, March 1996, 10. For examples of new funds being launched, see: Discreet Charm of Debt, 2 Emerging Markets Investor, Dec 1995, 6; Adam Courtenay, Opportunity knocks as Peru rings changes, Sunday Times, June 18, 1995; Clifford German, Gambling on Third World debt, The Independent, Nov 18, 1995, 26; Duncan Hughes, Bond fund targets emerging markets, South China Morning Post, Oct 29, 1995, 12.
[345] Riva Atlas, The Brady Bunch, Forbes, June 19, 1995, 194.
[346] Abby Schultz, Mutual Funds Report; Yes, Those Junk-bond Funds Are Still Cheap, but Go on Tiptoes, The New York Times, Jan 10, 1999, section 3, pg 51, col 1.
[347] Susan Hogg, Running uphill, 2 Emerging Markets Investor, Sept 1995, 37.
[348] John Waggoner, Peso pummels emerging markets funds, USA Today, Jan 3, 1995, 3B.
[349] Susan Hogg, Running uphill, 2 Emerging Markets Investor, Sept 1995, 37.
[350] Stan Hinden, While Latin American stock funds sagged, bonds romped, The Houston Chronicle, Jan 29, 1996, 7.
[351] Kevin G Hall, Latin America Economies Vulnerable to Uninformed Investing Decisions, J. Comm., April 28, 1995, 3A. As an example of the size and diversity of these funds, consider the two Societe Generale managed funds launched in late 1993 and early 1994 with initial asset values of 1 billion and 2.2 billion French francs, respectively: French Bank leverages emerging market fund, 1018 IFR, Feb 19, 1994.
[352] Mitchell Martin, Wall Street Sees Red at U.S. Plan for Bondholders to Accept More Risk, International Herald Tribune, April 26, 1999, 16.
[353] Susan Hogg, No redeeming features, 2 Emerging Markers Investor, May 1995, 34 at 36; and Mike Goodman, Investment Trusts Survey: Emerging again as a favorite, The Daily Telegraph, Jan 6, 1996, 16.
[354] This was a neat reversal of the trend in 1994 when closed-end funds accounted for 64% of the total. See Susan Hogg, Running uphill, 2 Emerging Markets Investor, Sept 1995, 37.
[355] Capital flows to developing countries shrink slightly, Business Times (Malaysia), Dec 26, 1995, 5.
[356] Ted Caldwell quoted in Kerry Fraser, “Doing their own thing, Emerging Markets Investor, Aug 1995, 11.
[357] Claire Makin, Doesn’t anybody remember risk? Institutional Investor, April, 1994, 41.
[358] Kerry Fraser, Doing their own thing, Emerging Markets Investor, Aug 1995, 11.
[359] Fraser, Id.
[360] Claire Makin, Doesn’t anybody remember risk?, Institutional Investor, April, 1994, 41.
[361] Sandeep Dahiya, The risks and returns of Brady Bonds in a portfolio framework 6 5 Financial Markets, Institutions and Instruments 45 (1997)
[362] Dirou & Buckley, “Strengthening the International Financial System”, a forthcoming article.
[363] The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 11; Brady Bond Review: Major strides forward, 1164 IFR, Dec 21, 1996; Brady Bonds -- Too good to last, 4 Emerging Markets Investor, Jan 1997, 17; and Venezuela bids farewell to Bradys, 106 Global Investor, Oct 1997, 17.
[364] Keith Mullin, Foreword 1230 IFR, April 25, 1998.
[365] Alex Crossman, What happens next?, 1214 IFR, Dec 20, 1997.
[366] Emerging Markets: Stellar year for LatAm Bonds, 1167 IFR, Jan 25, 1997.
[367] Russ Wiles, Income Investor -- Something for the Adventurous, Los Angeles Times, Jan 14, 1997, at D8.
[368] World Bank, Global Development Finance 1998, 17.
[369] Rob Spence, Who’s afraid of the big, bad hedge funds? 4 Emerging Markets Investor, Oct 1997, 17.
[370] These estimates are from Tass Management, as cited in Spence, Id., and World Bank, Global Development Finance 1998, 17, respectively. Hedge funds attracted considerable criticism for precipitating the Asian Economic Crisis, however, this is an oversimplification. Hedge funds are an easy target to blame for a crisis caused more by excessive capital flows from developed countries, inadequate local prudential supervision, and overvalued exchange rates than by the actions of these speculators.
[371] Mullin, supra..
[372] Paul Farrow, That’s all folks, 1207 IFR, Nov 1, 1997.
[373] Melvyn Westlake, Asia’s new junkyard, 5 Emerging Markets Investor, Feb 1998, 15 at 17.
[374] Rob Spence, Live and ticking, 3 Emerging Markets Investor, May 1996, 16.
[375] Spence, Id.
[376] Spence, Id. at 17.
[377] Spence, Id. at 18.
[378] Jack Willoughby, Emerging risk, Institutional Investor, Dec 1997, 39.
[379] Spence, Live and ticking, 3 Emerging Markets Investor, May 1996, 16 at 19.
[380] Spence, Id.
[381] Spence, Id.
[382] Spence, Id.
[383] In Alan Greenspan’s words, “With the new more sophisticated financial markets punishing errant government policy behaviour far more profoundly than in the past, vicious cycles are evidently emerging more often.”: Remarks by Chairman Alan Greenspan, Before the Annual Financial Markets Conference of the Federal Reserve Bank of Atlanta, Miami Beach, Florida, February 27, 1998. See also The World Bank, Global Development Finance 1997, Vol 1 (Washington, DC: World Bank, 1997) 4; and Lee C Buchheit, Cross-Border Lending: What’s Different This Time?, 16 Northwestern J. Int. L Bus., 44 at 54-55 (1995).
[384] At the crossroads, IFR Special Report (n.d.), 22.
[385] Francis Flaherty, Bullish Bond Funds Mine Emerging Nations, The New York Times, Sept 24, 1994, at 31, col 1.
[386] Lee Yoke Har, Brady bonds: stronger now, Business Times (Singapore), March 15, 1997, 4.
[387] Kevin Muehring, Looking for a lasting relationship, Institutional Investor, July, 1995, 45.
[388] Gary Evans, Identity crisis, 2 Emerging Markets Investor, Feb 1995, 45 at 46.
[389] Yields on emerging-market debt have risen sharply, The Economist, Jan 21, 1995, 78.
[390] Emerging Markets Traders Association, 1996 Debt Trading Volume Survey Supplemental Analysis, March 17, 1997, 1.
[391] Robert Rubin, Treasury Secretary Robert E Rubin Remarks On Reform of the International Financial Architecture to the School of Advanced International Studies, Federal Department and Agency Documents, April 21, 1999.
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