Blain’s Morning Porridge 25^th Nov 2024: BRICBonds – the Emergence and Implications of a New Bond Market

Change is inevitable. Evolution, however, is optional.

China issued $2bln of Bonds via Saudi Arabia last week. Some think it’s part of a malign plan for China to disrupt the global dollar bond markets. It may be the trigger for a dramatic rethink and recalibration of how global markets finance future credit. As geopolitical flux deepens, how might a new bond markets evolve?

Last week I missed the emergence of what I reckon could become an entirely new bond market: BRICBonds. It was kicked off by China raising $2bln by issuing a dollar bond listed and sold via the Saudia Arabian market. There are rumblings around the market old-school the deal represents the China/Saudi axis plotting something nefarious in the dollar bond markets. Maybe – but probably not.

But it is very interesting, and a bit of disruption is not always a bad thing. While some commentators are looking for evil intent and malign motives, I’m wondering if a new BRICs market might point to a resurgence of “Emerging Market” funding in a new, (dare I say this) potentially more effective and more inclusive format than current “Pale and Stale” Western dominated financial markets which tend to favour established borrowers and minimal risk?

Concurrent tides in global finance have set me thinking what a future bond market might look like. These reflect the reality of how dramatically new geopolitical fault-lines and alliances have emerged and developed in just a few years:

• We are in a period of acute geopolitical entropy as new nations, China, India and others challenge the established world order and their place in it. Europe looks tired. The role of the US as global hegemon and the dollar at the centre of a dollarized global economy is no longer assumed to be permanent.
• The COP29 meeting in Baku cobbled together a contentious $300 bln annual finance plan to assist developing nations to address global warming and climate change. Many nations felt sidelined by the carve up – accusing the developed west of avoiding “responsibilities” by not agreeing a larger package.
• China has announced a 6 trillion Yen ($840 bln) federalisation of local authority debt.
• President-Elect Trump’s clear intention to withdraw from any global climate agenda and isolate the US economy from “threatening” global trade, leaves an enormous gap in Western leadership.
• The recent BRICS summit in Kazan, Russia, highlights a new world order intent of “bypassing Western States and Institutions”. BRICS nations represent nearly 40% of the Global Population, and 38% of Global GDP.
• Saudi Arabia, the UAE and Iran are potential BRICS members – and have effectively de-aligned from the US sphere into China’s orbit, taking much of global oil supply with them.
• 152 nations are signed up in some format to the China Belt and Road initiative (“BRI”) – effectively partnering China to facilitate the infrastructure of global trade, on China’s terms.

The world… is changing… faster that we can spot looking out of London’s trading floor windows.

The new China BRICBond deal was 20x oversubscribed at nearly $40 bln, hovering up demand from “global investors” – whom I’m told were likely Chinese domestic investors (who garner a favourable regulatory and tax advantage from holding domestic sovereign bonds), and Middle East SWF investors wanting to demonstrate China exposure, but in dollars rather than the renminbi their governments have agreed to receive for oil exports.

What was interesting was the deal was priced flat to US treasuries. China is rated A1 compared to the US (still) a Aaa credit. The spread between the US and China, plus the fact the US Treasury market is the deepest and most liquid traded bond market, while this deal is a “tiny” 2 bln soon-to-be-illiquid jumbo, would normally be some 20 bp wider to reflect risk and liquidity.

The new China “BRICBonds” are an evolution of the Eurobond market which emerged in the 1960s as international markets recycled offshore US$ petrodollars. In just a few decades the Euromarket had become the largest part of the newly globalised financial markets centred in London. (I got my start on the bond origination desk of a then new to Europe US Bank in 1985, playing the Eurobond markets.)

I am sure the Saudi financial authorities see much the same opportunity  – potentially establishing Riyadh as the centre of a new market originating and trading BRIC and BRI sovereign and credit bonds to recycle the Middle East’s petrodollars into bonds issued by BRICs Sovereign, agencies, entities and corporates. Access to international finance in a new BRICbond format could prove much more attractive to Poor South, climate-stressed nations than the traditional Eurobond market.

Let’s be honest – current global credit markets reflect how London, New York, Frankfurt, Tokyo, and Paris think the globe should work. These reflect Western bias and inherent prejudice – which have been established over centuries. Maybe it’s time for a new market with a new outlook? (Or maybe just one that ultimately reflects China’s bias and prejudices?)

The new China deal has been launched to target specific demand. Had the bond been priced at a premium to the “normal” China/US credit spread, then demand would have been even larger and probably global. Experience teaches niche Eurobond markets – like Sukuk bonds (Islamic compliant bonds) – will swiftly trade at effectively the same credit spreads as wider global bond markets.

What happens if the new BRICBond market becomes the go-to market to finance and invest in Poor-South and climate-change sovereign, agency and corporate debt? Will it start to crowd out money that’s traditionally flowed into “Western credit markets”?

There are massive implications – if Middle East oil dollars are financing China and other BRICs credits, then they won’t be financing the US budget deficit, causing all kinds of potential problems for the US. Losing control of its bond market would be a crisis for a careless US administration. However, there are some inbuilt system fail-safes to mitigate against such a meltdown.

Rule number 1 of Sovereign Debt Markets is financially sovereign nations don’t default – on debt in their own currency. In times of crises they can raise interest rates and/or print money. Nations default when they can’t pay back cash they have borrowed in other nations currencies – which is why Argentina is a serial defaulter of bonds it issues in US dollars. While holders of US$ denominated BRICBonds will be delighted by a stronger dollar, it significantly raises credit risks and the likelihood issuers will default because they can’t afford more expensive dollars to repay their debt!

The recent BRICS conference explicitly recognised the dollar gives the US undue influence and advantages in the global economy. China would clearly like the Renminbi to have a similar advantage – especially when domestic credit is tight. The problem for China is: how could they create a global RMB market? Global markets function on dollars because they function on dollars! Simple as…

Of course, China and Saudi could do something tricksy – like offering all holders of these new US$ BRICBonds the option to exchange their bonds into exactly the same bonds, but denominated in a new China digital currency. (Yep, a proper use of blockchain.) That sounds impossible – how could China simply switch dollar assets and liabilities into Rmb assets and liabilities?

The question to ask is Why Not? Money is not sacrosanct – it is simply a medium, it exists in book-entry form created by the extension of credit by banks and governments. Physical greenbacks don’t exist in Eurobond markets. The underlying BRIC bonds would still represent the same asset and liabilities – just with a different entry on the currency input.

But would it work? The globe uses dollars because it uses dollars. If BRICBonds provide a solution to climate finance, and for a new more focused emerging credit market – then why not? There would still be offshore dollars in circulation, but less demand for them making the new Rmb effectively the debt choice for BRICs borrowers. I suspect global markets would accept de-facto change and switch faster than we currently think possible. We may be dinosaurs here on London trading floors, but global markets are constantly evolving.

Out of time, and back to the day job…

Bill Blain

Author of the Morning Porridge, founder of Wind Shift Capital

www.morningporridge.com

www.windshift.capital

billblain@morningporridge.com