1 Introduction
The growth of debt capital markets in emerging economies worldwide, including in the Bank’s countries of operations, has shown its potential to become the catalyst for economic growth. This reflects the improvement in private sector credit quality, regulatory and transactional transparency and, in turn, leads to growing domestic liquidity. However, both the financial crises of the past and the economic challenges presented by the current pandemic, underline the need for further development of liquid and self-sufficient local currency capital markets in these economies.
For example, experience shows that resilient and efficient local debt capital markets can help emerging economies reduce their financial vulnerability in times of crises. Local capital markets provide a destination for domestic savings, can facilitate more efficient resource allocation, lower transaction costs, and raise the productivity of resources through invention, innovation and technological progress, all primary factors in stimulating economic growth.1 Several studies show a direct link between the development of capital markets and economic growth.2
Several macroeconomics books and studies have analysed various stages of capital markets development and compared economic growth indicators. They suggest that developed capital markets have a positive correlation to economic growth as they allow easier and more efficient long-term local currency financing, more efficiently channelling domestic savings into the real economy and encouraging local businesses to expand and grow.
The ebrd has been committed to the development of domestic capital markets in the countries of its operations since its establishment. In fact, one of the primary functions of the Bank, under the Agreement Establishing the ebrd, is “to stimulate and encourage the development of capital markets”.3
2 Rationale for Local Currency Financing
Why is local currency financing such an important part of the Bank’s mandate? Except for exporters and companies with foreign currency receivables, borrowers in the Bank’s regions are generally not able to efficiently manage currency risks. Hence, foreign currency loans are not an appropriate financing option for them. The Bank’s lending in local currency becomes an important tool in mitigating or eliminating the currency exposures of such borrowers.
By providing loans in local currency, the Bank helps to improve the creditworthiness of projects that generate only local currency income, as it reduces foreign exchange risk. The Bank is also able to extend the maturity of local currency financing in the market as it can direct domestic liquidity that is mainly available on a short-term basis, into longer term lending in local currency. In addition, depending on applicable local legislation, projects in certain jurisdictions may be legally required to be funded only in local currency, for example, projects in the municipal sector.
At the same time, by borrowing in local currency, the Bank helps to stimulate the development of local capital markets. Bonds of an issuer with triple-A rating, such as the Bank, provide an alternative and transparent pricing benchmark to the government bond market. For domestic investors, the ebrd bonds serve as an additional investment asset of the highest credit quality, the choice of which is usually quite limited in local markets, and provide an opportunity for credit diversification in their portfolios. They also attract new investors that want to gain exposure to local currency without being exposed to local credit risk. Investing in the Bank’s local currency bonds often brings new investors to local markets and encourages them to concurrently invest in the local government and corporate debt market. In addition, this enables the Bank to introduce innovative techniques in local currency financing activities that help foster the overall development of the market.
The ebrd has issued bonds in local currency in a number of domestic markets, including Hungary, Russia, Armenia, Georgia, Serbia, Kazakhstan, and Eurobonds in the currencies of many of its countries of operations. In
3 Developing the Legal Framework for Local Bond Issuance by International Financial Organizations
Issuing the first local currency bond in an ifi’s country of operations usually represents the culmination of work of amending or devising local legislation, over months and years, sometimes decades. The Bank’s experience has been that developing liquid local bond markets in transition countries is a process that requires a comprehensive reform of financial regulations and institutions, which takes both time and funding.4
The changes that are required to achieve a regulatory framework considered acceptable for an ifi bond issuance, encompass a wide range of issues: In addition to favourable issuance and disclosure rules, there needs to be a functioning market infrastructure to mitigate a host of risks, including legal, settlement and regulatory risks. A significant number of changes is usually required in order to achieve a working settlement system, properly functioning depositary services, an appropriate base of investors, clear rules for admission to public trading, a credible money market index, adequate regulation of bondholder rights and representation, etc.
As underlined by the International Monetary Fund, it is widely acknowledged that robust legal and regulatory frameworks are critical building blocks for the structure, development and functioning of local currency bond markets.5 In this regard, while focusing on the immediate purpose of issuing local currency bonds in a particular country, the Bank aims for the introduction of best international practices and the development of instruments and rules that would benefit all market participants, and not just ifis.
The approach to regulatory reforms in any particular jurisdiction needs to be individually tailored, as successful policy and structural reform ultimately depends on its specific circumstances, including a country’s stage of development and sequencing of other reforms.
ifis are established by, and function under, international treaties between sovereign states and, in many respects, these organisations are very different from corporate entities established under national laws, including in their legal status, especially their immunities and privileges, as reflected in their internal procedures, decision-making processes and documentation. As they are established to achieve positive societal objectives for their members or broader stakeholders, these organizations are designed to adhere to and advocate the highest standards of conduct in the various environments in which they are involved, including local capital markets. Therefore, in order to enable an ifi issuance of securities in a local capital market, applicable legal regulations need to ensure that the specificities of ifis are recognised, and potential obstacles removed.
With this in mind, various registration, procedural and documentation requirements applicable to the process of securities issuance and placement should be reviewed and amended to adapt them to ifi expectations. It is equally important to make sure that any requirements of information disclosure applicable to the ifis, both in the form of prospectus disclosure and ongoing disclosure, take into account their special status as international organisations and do not impose restrictions and requirements that are overly burdensome.
3.1 Issuance Rules
Bonds issued by ifis are rarely envisaged by local securities legislation of the Bank’s countries of operations. They need to be expressly included in the types of securities authorised under local securities law and ifis recognised as eligible to issue bonds in the relevant local market(s). This means that, due to their special status and specificities, ifis should either be entirely exempt from national rules on bonds issuance or, more likely, national laws should provide for specific issuance procedures for ifi bond issuance. In this regard, national law may specify that such exemptions or special rules apply to all international organizations, or only to ifis of which the particular country is a member or choose to provide a specific list of ifis eligible for such exemptions.
In short, in formulating reform to encourage ifi issuances, it is important to ensure that national laws governing the issuance of local currency bonds do not pose obstacles or envisage any requirements, which would not be standard from an international debt capital markets perspective.
3.2 Credit Rating
Local regulations often require a specific credit rating as a condition for ifi local currency bond issuance and it is not always clear whether such rating relates to the issuer or to each bond issuance. Sometimes there is a requirement to obtain a rating by a local rating agency. Given the generally extensive and well-tested ifi bond issuance programmes, it is reasonable to require that the relevant ifi’s credit rating by an internationally recognised rating agency be sufficient for a local bond issuance.
3.3 Information Disclosure
The Bank frequently has to persuade local regulators and authorities to exempt ifis from the local disclosure requirements that are applicable to corporate issuers and allow them to fulfil transparency requirements that apply to them in international markets and that are familiar to them, and in accordance with their special status, constituent documents and standard operating procedures.
ifis are large organizations, issuing securities in many international and domestic markets. It would not be practical and perhaps not possible for them to disclose material information on their operations and activities in the varied languages, formats, and timelines that would be necessary if the disclosure rules applicable to corporate issuers in each such market were to apply. On the other hand, generally, ifis’ activities and financial position are already made transparent and disclosed to the public in accordance with their treaties, internal by-laws and procedures.
Disclosure regulations that usually apply to public international bodies in connection with their public issuances often recognize such specificities in
ifis, like the ebrd, are also exempt from on-going disclosure requirements in EU markets. Under the EU Transparency Directive, the rules on disclosure of annual financial reports and half-yearly financial reports do not apply to a state, a regional or local authority of a state, a public international body, of which at least one member state of the EU is a member, the European Central Bank (ecb), the European Financial Stability Facility (efsf) established by the efsf Framework Agreement, and member states’ national central banks whether or not they issue shares or other securities.7
Many countries in the ebrd’s regions of operations now follow this approach, allowing ifis that wish to carry out public offerings, and whose securities are already admitted for trading on one of the recognized international stock exchanges, to disclose information in the same form, at the same time and in respect of the same timeframes. This allows ifis to disclose information in local markets in the way to which they are accustomed and to carry out only a customary ongoing disclosure. Certain countries in the ebrd’s regions have also agreed to allow the disclosure of information by ifi issuers in the English language.
3.4 Use of Proceeds
Local regulations may sometimes contain certain restrictions regarding the use of proceeds of bond issuances by international issuers. In certain countries,
3.5 Other Regulatory Issues
In addition to general rules relating to the procedure of bond issuance and information disclosure, issuers often face other issues in emerging markets that can be challenging. These include currency control restrictions, banking restrictions on non-residents, burdensome listing requirements, and many others. For example, certain restrictions may apply to non-nationals opening bank or securities accounts with local banks, registrars, or custodians for the purposes of offering, repurchasing and redeeming bonds or paying interest and other income to investors. There may also be currency control restrictions that adversely affect the ability of foreign investors to invest in local currency debt instruments. In some countries in the ebrd regions, issuers are sometimes faced with rules that require a delay in trading of the issued securities until the issuance report is approved by the relevant regulator.
Additionally, there is a limited potential investor base, as national laws in many countries in the ebrd regions do not allow institutional investors (e.g., pension funds or insurance companies) to invest in securities of foreign issuers, including those issued by ifis.
The Bank is working with local authorities and regulators with a view to lift such restrictions and bring in best international market practices. The ebrd is also working on the development of the investor base in a number of countries of its region, trying to expand potential pool of local investors and bring in international investors to local markets.
4 Developing Local Capital Markets Operational Infrastructure
In addition to regulatory aspects, issuers in many countries in the Bank’s regions also face challenges caused by the insufficient development of the local capital markets’ operational infrastructure. These may include fragmented depositary arrangements, a rudimentary and insufficient clearing and settlement system, a lack of credible money market index, and others.
The ebrd frequently provides technical assistance to its countries of operations, aimed at building a sound capital markets infrastructure and achieving a
4.1 Challenges for the Bank’s Reform Projects
Pursuing the task of changing local legislation and infrastructure requires not just technical expertise, for which the Bank has been long praised. It also requires the building of relationships with local authorities and sometimes to be ready to re-start the engagement process from scratch when governments or relevant officials change. It also requires skills to persuade them to follow best international practices. Often, it requires diplomatic skills to promote collaboration between various governmental authorities, in order to achieve the required functionality of the market as a whole.
Communication is, of course, essential for achieving the desired results, and it is important to engage with relevant stakeholders at an early stage. This helps build trust with and obtain the commitment of local authorities, which is a critical element without which no reform project can be successful.
The results of such engagement can be rewarding. Once the necessary regulatory and operational framework is in place, the Bank usually starts with a simple fixed or floating rate note issuance before moving to more complex and innovative structures. For example, following a simple floating rate note offering, the Bank issued index-linked, equity linked and commodity-linked notes in one of its countries of operations. These complex structured bonds may seem relatively usual in the developed capital markets, but they represent significant milestone events for local capital markets, where the choice of financial instruments available to investors is quite narrow and the regulatory environment restrictive, confusing and often in flux. Hence, each debut issuance in a local capital market usually represents a landmark event as it has an important demonstration effect and serves to attract new long-term investors to local markets.
5 The Bank’s Reform Projects Aimed at the Development of the Derivatives Market
One of the important pre-requisites for an efficient capital market is the development of financial derivatives and access of local and international participants to domestic hedging instruments. Derivatives are a tool to manage exposures to, amongst others, interest rate and exchange risks, and this is exactly the use that the ebrd promotes across its countries of operations.
According to the recent research published by the Bank for International Settlement, “only 10% of global derivatives turnover is in contracts denominated in the currency of an emerging market economy (eme), much lower than the share of these economies in global gdp or world trade. Derivatives in eme currencies also tend to be less complex and more likely to be traded outside the home economy than those in advanced economy currencies”.8 The reasons for this statistic are several and complex, but the major one is the lack of adequate protections for participants in the local derivatives market. For example, in many emerging markets, the legal and regulatory framework does not provide for the enforceability of derivative transactions or for legal concepts such as close-out netting or financial collateral. In some cases, derivative transactions are even classified as gambling and are therefore considered unenforceable.
Over the years, the Bank has been actively involved in projects aimed at the development of favourable netting and collateral legislation in its countries of operations. As part of the Bank’s technical cooperation projects, a package of laws, aimed at the development of netting and collateral structures, has now been passed in each of Armenia, Croatia, Georgia, Latvia, Serbia and Ukraine. New legislative frameworks in each of these countries, established as a result of Bank-led reforms, provide for the enforceability of derivatives transactions, including netting, close-out netting and financial collateral, and reinforce key related concepts, such as settlement finality. Such new legislation allows companies to more safely and efficiently hedge their risk and exposure, including foreign exchange and interest rate risks, and contributes significantly to the development of a local currency financial market. These reforms also provide the green light to cross-border derivatives transactions, which could help attract additional financial resources to each of these countries.
The Bank has been working in these countries in cooperation with, and with the full support of the International Swaps and Derivatives Association (isda). In carrying out these technical cooperation projects the Bank has followed the guidance of core international derivatives templates, including the isda Model Netting Act and Guide,9 the unidroit Principles of Operation
Needless to say, in order to be implemented efficiently in practice, such international best practices need to be organically adapted to national legal systems, tradition and terminology. While working on each derivatives project, the Bank seeks to weave these concepts into local legal systems, by amending laws and regulations in each such jurisdiction, trying to eliminate the risk of re-characterization of these novel concepts and structures, which may nullify the transparency and assurances sought by market participants. Equally, the Bank aims for the recognition of the contractual documentation and structures used in international markets for documenting derivatives transactions, such as the isda Master Agreements.
Following the success of the ebrd reform projects, with the passing of the relevant legislation, the isda netting legal opinions for Armenia and Georgia were published in October 2019 and July 2020, respectively. Relevant derivatives legislation was enacted in Ukraine in August 2020, and close-out netting law implemented in Latvia in September 2021. The ebrd is continuing its efforts of developing netting and collateral legislation in its other countries of operations.
6 Conclusion
Over the past thirty years, the ebrd has built a reputation among its member states and beyond as a source of expertise, a trusted counterparty and a partner to local authorities in developing local capital markets. The Bank’s involvement, both on the regulatory development level and by way of issuing bonds and entering into financial transactions in local markets, is widely recognised as contributing significantly to the development of capital markets in the countries in its regions to what is, in many ways, a historic transformation of the financial systems of its countries of operations into operational, more liquid and more resilient local financial markets.
Associate Director and Senior Counsel, European Bank for Reconstruction and Development, sulimae@ebrd.com.
See, for example, Levine and Zervos 1996; Zhuang et al. 2009.
Agreement Establishing the European Bank for Reconstruction and Development (Chapter 1, Article 2. Functions).
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Article 1.2(b) of Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the Prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/ec.
Article 8.1(a) of Directive 2013/50/EU of the European Parliament and of the Council of 22 October 2013 amending Directive 2004/109/ec of the European Parliament and of the Council on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market, Directive 2003/71/ec of the European Parliament and of the Council on the prospectus to be published when securities are offered to the public or admitted to trading and Commission Directive 2007/14/ec laying down detailed rules for the implementation of certain provisions of Directive 2004/109/ec.
bis, Quarterly Review, Emerging Derivatives Markets, 2016.
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Bossu W; Hillier C and Bergthaler W, imf Working Paper “Local Currency Bond Markets Law Reform: A Methodology for Emerging Markets and Developing Economies”, (20 November 2020), <https://www.imf.org/en/Publications/WP/Issues/2020/11/20/Local-Currency-Bond-Markets-Law-Reform-A-Methodology-for-Emerging-Markets-and-Developing-49905>, accessed 16 June 2022.
European Bank for Reconstruction and Development (ebrd), Agreement Establishing the European Bank for Reconstruction and Development, (28 March 1991), <https://www.ebrd.com/news/publications/institutional-documents/basic-documents-of-the-ebrd.html>, accessed 16 June 2022.
European Bank for Reconstruction and Development (ebrd), Local Currency Operations of the ebrd: Considerations on Country and Client Selection, (November 2006),<https://www.ebrd.com/cs/Satellite?c=Content&cid=1395239594111&d=&pagename=EBRD%2FContent%2FDownloadDocument>, accessed 16 June 2022.
Levine R and Zervos S, Stock Markets, Banks, and Economic Growth, (December 1996). Available at ssrn: <https://ssrn.com/abstract=60141>.
Todaro M P and Smith S C, Economic Development, 11th ed.; Pearson: Harlow, UK, 2011.
Zhuang J et al., Financial Sector Development, Economic Growth, and Poverty Reduction; Economics Working Paper Series Number 173; Asian Development Bank: Manila, Philippines, 2009.