On the subject of the term ‘frontier market’ one is tempted, increasingly, to conceive of it as a category error – a flawed item in the taxonomy of capital markets which increasingly falls wide of the mark when it comes to accurately describing its referent.
‘High-yield’, for example, refers to an asset class which nowadays delivers returns that used to be (not so terribly long ago) standard in high-grade benchmark markets such as US Treasuries and Bunds; ‘yield’ meant something that gave you a return on your money, not something which subtracts earnings from your capital, as do the government bond markets of Germany and Japan.
Then again, the capital markets cannot do without shorthand semantics, even if it must be accepted that the terms in use will shift in meaning, sometimes radically, to become functionally redundant.
In APAC there were the ‘tiger economies’, the sexiest term (perhaps) to cross the lips of every trader, fund manager and DCM pitcher in the 1980s and for much of the 90s and early noughties.
But many of those tiger economies must now be placed in the developed, fully emerged basket – one thinks of China, Singapore and South Korea as prime examples.
And so the line of thought must be that today’s ‘frontier’ economies and the capital markets they contain are likely to be prime exemplars of this category error.
All of which is a way of saying that the shifting semantics which are a feature of capital markets – blue chips become pink sheet has-beens, unicorns become turkeys – contain the essence of the market’s identity and the motivation of its participants.
The markets are always looking for the next category – whether with its demise built-in at conception – and the category which has excited for some time is the frontier economy and the potential it presents to capital markets operatives.
That potential has hardly been lost on them: almost 20 years ago, the offshore public G3 markets in Asia were exercised into nascent frenzy by talk of a debut dollar bond from Cambodia. The deal never happened but the potential it presented was lost on very few market players.
And once again, frontier markets exercised the imaginations and piqued the ambitions of the region’s capital market bankers last year when a failed deal for Laos – after three attempts under the auspices of Oppenheimer – and a rip-roaring tender and new issue exercise from Mongolia, reminded them they they should be taking their pitch books (by Zoom if not face-to-face) to the national and corporate treasuries of places such as Vientiane and Ulan Bator.
Much as categories and fashions shift rapidly in capital markets, their unfailingly distinctive feature is the possession of a short memory.
The stomach churning experience of the Asian financial crisis of the late 1990s was long ago erased from the market’s collective memory, along with the dynamic which caused it – the ‘double mismatch’ of tenor and currency via borrowing in offshore markets, otherwise known as ‘original sin’.
And without original sin and the availability of the debt and loan markets to provide hard currency borrowing with seemingly infinite largesse, arguably the tiger economy phenomenon would not have emerged.
But as the US$600m Mongolia deal – which involved a tender for paper maturing this year and next and the offering of new five-year paper – demonstrated, original sin has not gone away, or at least not the currency component of the sin.
And there’s an important reason for that: only the offshore debt capital markets can provide depth, diversity of investors, secondary market liquidity and term funding cost effectiveness. By contrast, local markets in APAC have proved somewhat flaky in terms of execution, pricing and secondary market liquidity.
Nevertheless, debt capital markets, by which I mean developed, liquid and transparent bond markets embedded in high standards of diligence and governance, are essential tools of economic development, and the means by which today’s frontier economies will transition to developed status.
That reality must be contrasted with loan capital which is an entirely different matter, and where China enters the frontier markets with a figurative punch. The country has long been providing concessionary loans to frontier economies, often tied to stringent security packages which underline what is in many cases a ‘loan to own’ strategy.
The most notorious example – and one that has become almost a cliche of egregious lending practice – is the port of Hambantota in Sri Lanka, the ownership of which fell into China’s hands when the government defaulted on loan payments, even though the loans were made at concessionary rates.
And to move further into the realm of the egregious, China’s development banks often make loans to frontier economies, whether in South-east and Central Asia or in Africa, on concessionary or commercial terms, with non-disclosure agreements a condition of the borrowing.
That means frontier economy balance sheets often contain contingent, undisclosed liabilities. And that fact has important implications for the development of those countries’ bond markets.
The ‘third time unlucky’ (yet again) trade for Laos was bedevilled by breach of terms related to lending to two hydropower projects in the country and negative pledge clauses.
Alright, the lending involved not just China – in the shape of the Export-Import Bank of China – but other regional development banks (including the ADB) and a syndicate of commercial banks. But the exercise demonstrated the dead weight potential of lending to impede bond market development, particularly as far as disclosure is concerned.
China’s mission, it would seem, as far as the frontier economies are concerned is to refer them into client states, shackled to loans which impede access to debt market capital and often pose the risk of asset forfeiture.
BELT AND ROAD
As the country’s mammoth Belt and Road infrastructure juggernaut, which aims to replicate the old Silk Road trading route which connected China with the West in ancient times, rolls on, that dynamic is not set to abate any time soon.
And the development of frontier bond markets is also crucial due to one fast-emerging variable: ESG. The stratospheric rise of capital invested according to ESG factors presents the frontier economies the opportunity to entice the wall of money that segment is fast deploying.
ESG was crucial to the success of the Mongolia deal, with the country’s ‘2030 Vision’ plan to transition away from a reliance on mining and towards sustainability enabling the new bond deal to tap into the sustainable money bid.
And Laos also possesses bullseye potential in the green energy stakes, with its production of hydropower clearly showing the way.
It would be a shame, to put it mildly, if that wall of money were to be denied entry to frontier economies by dint of non-disclosure loan clauses and the hazards they present to primary bond market access.
Easy solutions do not obnoxiously present as far as the national treasuries of frontier economies are concerned. But for a start, it behoves the region’s multilateral development banks to step up with greater urgency to help develop APAC’s frontier bond markets.
The ADB has played its part, with issuance in local currency, often in global issuance format, where the potential exists to access the aforementioned pool of ESG capital, as well as offering the potential alpha generation potential of local currency appreciation.
That would seem the best way going forward, if frontier economies are to move into a new category and not be doomed forever to client status.