Domestic Sovereign Debt Market Development: Policy Challenges Around the World Washington, April 14th 2003 Clemente Del Valle Chairman Securities Commission, Colombia

Based on the data gathered through regional surveys during East Asia (EAP) Latin America (LAC) Europe / Central Asia (ECA) Middle East / North Africa (MENA)

Reliance on external debt still significant External debt Domestic debt Note: Data as of end-2001, LAC, Indonesia and Thailand use June 2002 data

Fixed rate securities dominant in EAP and MENA Fixed T-bills & other discount paper IndexedVariable Note: Floating interests are common in LAC

Short term maturities are dominant in most emerging regions, except EAP < 1 year1 – 5 year> 5 years

INSTITUTIONAL FRAMEWORK

Ministries of Finances make most debt management decisions Singapore and Yemen – Central Bank (CB) Brazil – Ministry (domestic operation) & CB (international transactions) Hungary – independent entity Places responsibility for debt management in MOF Share between several division: split domestic and external debt management Central Bank (CB) – fiscal agent EXCEPT

Moving toward a transparent legal and regulatory framework Most common debt management objective: cost and risk minimization Development of an active secondary market Lengthening debt maturity and establishing benchmark yield curve Bulgaria Estonia Latvia Egypt Morocco Lebanon Singapore Malaysia Philippines Lebanon Egypt Singapore Malaysia Philippines

Limits on net increase are most common EAP (2) ECA (6) MENA (2) LAC (2) EAP (1) ECA (6) LAC (4) EAP (1) MENA (2) LAC (4) ECA (1) MENA (3) EAP (3) LAC (1) ECA (1) MENA (2) LAC (1)

Supervision function are generally delegated to specialized authority Involving the CB and / or Securities Commission ECA Specialized authority is the sole or main supervisor of the market Korea Croatia Czech Rep Hungary Poland Slovenia Jordan Colombia Mexico Peru Costa Rica Central Bank Yemen Malaysia Singapore Lebanon MOF is not involved in the supervision

Yes No EAP (4) ECA (9) MENA (4) LAC (6) EAP (3) ECA (9) MENA (7) LAC (4) Government securities play important role in monetary policy Does the Central Bank issues securities? Main monetary policy instrument: Chile, Costa Rica, Jordan, Indonesia, Malaysia, Korea, Philipines, Brazil, Argentina y Colombia CB – conduct outright or repo sales/purchase for monetary policy transaction: ECA y MENA countries

EAP (4/6) ECA (14/20) MENA (7/7) LAC (8/10) Auctions are the main mechanism for primary issuance EAP (3/6) ECA (5/20) MENA (0/7) LAC (6/10) EAP (1/6) ECA (1/20) MENA (0/7) LAC (4/10) EAP (2/6) ECA (3/20) MENA (2/7) LAC (2/10) EAP (4/6) ECA (n.a) MENA (1/7) LAC (n.a)

PRIMARY MARKET

Issuance program enhance transparency Most countries publicly announce an issuing program on a periodic basis, except : Ecuador, Honduras, Paraguay, Egypt, Estonia and Turkey Most securities are issued according to a preannounced regular schedule, except: Jordan, Lebanon, Tunisia, Thailand, Croatia (issued at irregular intervals) The volume of offered securities is preannounced, except: Costa Rica and Turkey

Auctions procedures EAP (6/6) ECA (11/20) MENA (4/7) LAC (4/12) EAP (4/6) ECA (15/20) MENA (5/7) LAC (5/12)

Reopenings and advance redemptions not widespread Legal Obstacle Exists Technique is Used Comments EAP 05Not used in Indonesia and China ECA 011 MENA 22Used only in Lebanon and Tunisia LAC 5n.aUsed only in Brazil, Costa Rica, Colombia, Mexico, Peru USE OF REOPENINGS AND ADVANCE REDEMPTIONS (Number of Countries)

Reliance on nonmarketable securities in some countries The issuance of nonmarketable securities are not common in emerging regions, there are some exceptions: EAP - Singapore and China issue (50% of the total public debt securities outstanding) ECA - exist to a lesser extent, although Estonia has 100% of its domestic debt in this form (6.9% of total debt), and in Lithuania amount to aprox 33% of the total (6.1% of total debt)

Tax treatment of government securities Neutral and simple taxation policies are most desirable in developing government securities market Brazil Colombia Jamaica Capital gains withholding taxes and turnover taxes Least common in the MENA region Turnover taxes are still impose Discourage non resident investment : imposing a irrecoverable withholding tax * LAC and EAP countries * Even in some EAP countries where nonresident withholding tax is recoverable by law, in practice this process has not been successful – the Philippines Serbia Turkey China

SECONDARY MARKET AND INFRASTRUCTURE

OTC trading dominates, liquidity is generally thin LAC region Government Securities (GS) trading Exchange Costa Rica Honduras Peru Electronic Platform Brazil Colombia Argentina Relatively sizeable exchange trading of GS takes place: China (46%) Turkey (30%) In Russia, GS are only traded on the Moscow Interbank Currency Exchange (MICEX) In Albania there is no OTC market Secondary market trading is generally shallow, but most active are East Asia and LAC Electronic platforms are increasing share in many countries

Outright trading of GS still shallow in most markets NOTE: Turnover = annual trading volume / YE outstanding marketable GS. Excludes Slovenia and MENA countries – Algeria, Jordan, and Lebanon, where turnover is less than 0.1 times (or 10%) LIQUIDITY OF GS MARKET (TOTAL TURNOVER INCLUDING REPOS & OUTRIGHT) Only 20% of the countries have total turnover greater than 5 times the year-end outstanding marketable GS

Use of inter-dealer brokers is also lacking MENA countries is nonexistent ECA region: only exist in Hungary and Poland Asia: are becoming common (present in 4 markets) and plans are to implement them in two others (Indonesia, Thailand) LAC countries: they are common intermediaries in Mexico, Colombia and Brazil. support and enhance liquidity and price discovery in the secondary market Inter-dealer broker

Central Bank is the central depository for most GS Central BankSecurities Depository Both / Other institution EAPSingapore, Thailand, Malaysia, Indonesia ChinaKorea, Philippines ECAAlbania, Armenia, Bulgaria, Georgia, Moldova Estonia, Hungary, Latvia, Lithuania, Russia, Serbia, Slovenia Czech Republic MENAYemen, Lebanon, Algeria Morocco, TunisiaEgypt, Jordan LACBrazil, Colombia, Honduras, Uruguay Argentina, Chile. Ecuador, Mexico Costa Rica, Panama, Peru Total countries Institutions holding central depository functions

Clear tendency to move toward paperless securities 0% 0>x< 50%50%>x< 90%>90% EAP ChinaKorea, Thailand Indonesia, Singapore, Malaysia, Philippines ECA TurkeyHungaryArmenia, Poland, Albania, Bulgaria, Georgia, Latvia, Lithuania, Moldova, Slovenia MENA EgyptJordan, Lebanon, Morocco, Tunisia, Yemen LAC Costa Rica, Ecuador, Jamaica, Paraguay Panama, Uruguay Argentina, Brazil, Chile, Colombia, Honduras, Mexico Perú Paperless securities (in % of outstanding debt)

RTGS with DVP Net Settlement with DVP Gross Settlement without DVP EAP Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand China, Indonesia ECA Armenia, Bulgaria, Czech Rep., Hungary, Kazakhstan, Latvia, Poland, Slovenia Romania, Lithuania, Russia, Estonia Serbia, Moldova MENALebanon, MoroccoJordan, Tunisia LACn.a ECA and EAP region although they have achieved RTGS with DVP, they need to improve the functioning of existing arrangements (some still use gross settlement without DVP) Further development to achieve DVP still needed

Lack of basic hedging instruments affects the liquidity in secondary GS markets In Egypt all three types of transactions are restricted Restrictions on such activities are least common in the ECA and LAC countries Such transactions are not restricted in some countries, they do not take place (Yemen, Morocco, China, Indonesia, Philippines) Exacerbating the lack of liquidity in the secondary market are restrictions on liquidity enhancing transactions such as forward trading, lending / borrowing securities and short selling

INVESTOR BASE

Direct and indirect requirements to hold GS are commonplace BanksPublic sectorOther NOTE: For Czech Republic and Hungary, banks include the CB and securities firm. LAC data updated for June 2002 except Chile and Peru

There are only a few countries where banks and / or the public sector do not constitute the majority investor base for domestic GS: In Malaysia and Morocco, Pensions and Insurance companies are obliged to invest in GS for prudential reasons In Mexico regulation force the pension funds to hold at least 50% of their portfolio in GS bonds, while in Colombia pension funds are required to have no more than 50% (reforms on pension systems that introduced private asset management companies and force the contribution to achieve a fully funded system) In Hungary: foreign investors hold 24.7%, retail investors 20.4%; however, insurance companies are required to hold at least 40% of their insurance reserves in cash and GS Direct and indirect requirements to hold GS are commonplace

Conservative investment regulation and unlimited asset manager capabilities has been major obstacles Reforms on the pension system have been a major driver in LAC (Chile, Colombia, Peru, Bolivia, Mexico) However better synchronism is needed with capital markets reforms The mutual fund industry development has been scarce Brazil and Korea are two important exceptions Predominance of the banking activity has been an important limitation (LAC) The regulatory schemes of most of the countries has limited the development of Institutional Investors Limited development of Institutional Investors

Conclusions – Challenges for the Development of Domestic Sovereign Markets Growing consensus on the importance of this markets Most domestic bond markets are in a developing stage Countries like Brazil, Colombia, Korea, Mexico, Morocco, Singapore, Hungary, Poland and Turkey have taking significant steps, but are still far from an appropriate level of sophistication In general there has been a lack of comprehensive approach by Governments in this regards (no strong leadership by a government entity)

Conclusions – Challenges for the Development of Domestic Sovereign Markets Primary emphasis should be focused on stability: Sound fiscal and monetary policies Effective tax, legal and regulatory framework Smooth and secure settlement arrangements Development of money markets are a building block as well Need to upgrade debt-cash/management capabilities, to provide the market with a sound issuing strategy Need to develop a broader investor base for domestic bonds Need to build broad debt management capabilities in MOF (front, middle and back office)

Domestic Sovereign Debt Market Development: Policy Challenges Around the World Washington, April 14th 2003 Clemente Del Valle Chairman Securities Commission, Colombia