The rise and risks of global corporate bond markets

This is a speech made by Carmine Di Noia, Director of the Directorate for Financial and Enterprise Affairs at the OECD, during the OECD-IOSCO Conference on Corporate Bond Markets on June 24th 2022.

My presentation will take a long-term view of developments in primary non-financial corporate bond markets globally. My intention is to show the growth in this type of financing over time, how the gravity of bond markets has shifted geographically, and to ask how today’s market may develop given its current characteristics and ongoing macroeconomic developments. In doing so, I will also highlight some possible risks facing the market.?

As a starting point, the first global trend to consider is just how much non-financial corporate bond markets have grown in the past two decades. The two graphs shown here provide a good illustration. The blue one on the left shows the annual global issuance of non-financial corporate bonds. Between the two eleven-year periods from 2000 to 2010 and 2011 to 2021, that figure doubled from below 1.1 trillion US dollars per year on average to more than 2.1 trillion per year in real terms.?

In 2020, that number reached an astonishing 3 trillion US dollars. This was partly an effect of companies turning to the markets to meet liquidity needs in the face of large and sudden decreases in revenue and extreme economic uncertainty following the pandemic. But many also did it to build resilience to future shocks by creating buffers and extending maturities when possible.

Following this increase in issuance, at the end of 2021 the total stock of outstanding non-financial corporate bonds globally had reached 15.3 trillion US dollars, well above twice the amount outstanding in 2008, as you can see in the graph on the right.

That graph also shows a clear and rather sharp structural increase in outstanding amounts since the 2008 financial crisis – and remember that these figures are in real terms, that is to say accounting for inflation effects. This increase is an effect of a number of developments, but most notably of sustained expansionary monetary policies by central banks globally, and new, tighter post-crisis requirements for banks which has shifted the supply of credit away from the banking sector and towards the bond markets.?

A second trend to consider is the growth of Asian bond markets. The report we are releasing today, Corporate Finance in Asia and the COVID-19 Crisis, gives a detailed account of this development, together with many other trends, including for equity markets. The growth of Asia is clear – today, over half of the world’s listed companies are listed on an Asian exchange. I encourage you all to read the report to get a perspective on how Asian capital markets, corporate performance and government policies have developed in recent years, especially during the pandemic.

The graph on the left below shows how the Asian share of global non-financial corporate bond issuance has grown over time, from 15% in 2000 to 39% in 2021. And the graph on the right shows the main driver of this development – the astonishing growth of the Chinese market. From very small levels in the early 2000s, the Chinese market now makes up 61% of total outstanding amounts in Asia, followed by Japan at 17%. It is worth noting that the relative decrease in the Japanese share not an effect of any substantial absolute decrease in outstanding Japanese amounts, which have been relatively stable over time. Instead, it is an effect of the expansion of the Chinese market, which amounted to 2.3 trillion US dollars at the end of 2021.?

Returning now to global trends, an important development is the change in the composition of the market. Specifically, there has been a shift in the credit quality of issuance. As the graph on the left below shows, the share of non-investment grade, or “high-yield”, bonds in total rated issuance has been relatively volatile over time, but increased from 23% in 2015 to 35% in 2021.

In addition, as shown by the graph on the right, there is a sustained and clear change in composition of investment grade issuance towards lower rating grades. In 2000, triple B grades – the lowest investment grade rating class – made up less than a quarter of total investment grade issuance. In 2021, it was by far the largest category at over 57%. The corresponding decrease has taken place primarily in the triple and double A categories, the two highest classes. Triple A-rated bonds now only make up half a percent of investment grade issuance by amount.

The effect of these developments has been a structural decline in global bond credit quality. The OECD index on this slide shows the average value-weighted rating of corporate bond issues based on more than 70 000 bonds globally. While the development has been cyclical over time, the long-term trend is clear. From just below double A back in 1980, it had fallen to just half a notch above investment grade rating in 2021 – the lowest figure on record.?

The decrease in credit quality can also be seen in the extent of covenant protection offered to bondholders. The graph on the left below is an index of covenant protection for bonds issued in the United States by companies from the US and 66 other countries. Note how the index has fallen for non-investment grade issuers, from 47% in 2000 to 33% in 2020. This means there has been a decrease in the prevalence of covenants, which is an important creditor protection mechanism, in high-yield bond contracts.?

The graph on the right above is key to understanding both this development and the ones showed before. It is an indication of yields on non-investment grade bonds globally. Disregarding for the moment the spikes at the outbreak of the pandemic in the face of great uncertainty and more recently this year, the trend for yields during the past decade has been clearly downward-pointing.

In an environment of very low interest rates and a difficulty to find adequate returns in traditional instruments, investors have turned to riskier ones, in effect trading credit protection for higher yields. That greater demand for high-yield bonds, in turn, has increased their price and consequently driven down their yields.?

Now, crucially the conditions that drove down yields – low inflation and interest rates, and sometimes market support by central banks – are changing rapidly. As the graph on the left below shows, market inflation expectations have increased relatively sharply, and central banks globally are tightening monetary policy in response. At this stage, it is not possible to tell the extent to which inflation is driven by war- and pandemic-related supply chain issues and commodity price shocks. That makes it difficult to say what the global interest rate environment will look like going forward – but the current trend is doubtlessly towards tighter policy.

In this environment, significant amounts of outstanding corporate bonds are coming due within the next 3 years, representing 30% of total outstanding amounts globally, or about 4.6 trillion US dollars, as shown in the graph on the right below. In many cases, this debt will need to be refinanced in market conditions that are significantly less accommodative than the ones in which it was issued.?

These dynamics are especially sensitive for non-investment grade bonds. The graph below shows net issuance over time broken down by rating category. As you can see, non-investment grade net issuance was negative in 2008 during the global financial crisis, as well as in the second half of 2018 when increases in interest rates, announcements of less accommodative monetary policy and fears over slowing growth affected the market.?

While that development was reversed when monetary and broader economic conditions changed, both in 2009 and 2019, the issues we are facing today seem to have the potential of changing the macroeconomic environment more significantly, in particular with respect to inflation and interest rates. If you add to that the fact that the outstanding non-financial corporate bond debt is about 1.4 trillion US dollars higher today than in 2018, and 8.2 trillion dollars higher than in 2008, the outlook begins to looks very uncertain.

But let me stress here that when I say uncertain, I do not mean it as a euphemism for “bad”. In a very literal sense, what will happen next is uncertain – under the current circumstances it is very difficult to predict what will happen to inflation and global growth even in the relatively short term. But in the face of this uncertainty, we must be clear-sighted about the possible risks in our markets, to avoid that “uncertain” does indeed become “bad”.

Finally, to wrap things up, I would like to underline that a growing stock of outstanding corporate bond debt is also a good thing. Bond markets tend to offer longer maturities and greater flexibility than banks, especially in times of crises when bank credit usually contracts. That makes them important financing options for any company. Bond markets can also help provide a greater number companies with access to financing. And from a broader economic stability perspective, it is a good thing to decrease the concentration of credit supply, which has proved to have the potential of being very damaging.

So when we consider the risks of corporate bond markets, we should also remember their significant benefits – which make it all the more important to maintain their functioning globally.

On that note, ladies and gentlemen, thank you very much for listening.?