Emerging Market Bond Holders Face Liquidity Squeeze, Fitch Says

Emerging-market corporate bonds are so infrequently traded that holders may have trouble offloading them if market turmoil prompts a sudden selloff, a survey by Fitch Ratings Ltd. shows.

On more than half the trading days in the nine months through March, there were no transactions in 41 of the 100 largest dollar-denominated junk bonds sold by developing-country companies, according to the survey. That compared with less than 1 percent among peers in the U.S. Only 18 percent of emerging-market junk bonds changed hands on more than 95 percent of days, compared with 55 percent in the U.S.

Emerging-market corporate debt, a market that has tripled over the past five years to $1.4 trillion, is under investor scrutiny as the Federal Reserve’s move to raise interest rates increases the likelihood of a selloff. The lack of liquidity underscores the risk that traders may not be able to offload bonds when needed, which could exacerbate a rout.

The low trading frequency “suggests that additional market shocks, similar to those that have destabilized some emerging markets over the past two years, could trigger increased price volatility,” Fitch analysts led by Robert Grossman, wrote in a note. “Any significant increase in market volatility could lead to liquidity disruption for emerging-market bonds.”

Brazil, Russia

Investors may demand higher yields to compensate for reduced liquidity, making it more expensive and difficult for companies to raise funds, the analysts wrote.

Global bond trading volumes have deteriorated over the past few years as tighter financial regulations prompted banks to curtail their role as market makers. The lack of liquidity contributed to a selloff in emerging market assets in May 2013 when the Fed signaled that it may withdraw monetary stimulus.

Emerging-market borrowers tend to concentrate in a small number of countries and industries, further raising the risk of a market stampede when investors exit, Fitch said.

Brazilian and Russian companies account for 60 percent of emerging-market borrowers, while financial and energy firms make up 54 percent, according to Fitch.

“In a period of market stress, heavier volume and crowded trades in relatively illiquid bonds would likely contribute to further volatility,” the analysts wrote.

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