World Bank’s ID ETF is boosting local currency bond markets

Dan Barnes Welcome to ETF TV, I’m Dan Barnes. Today we’re going to be talking about the issuer-driven ETF and the program that the World Bank is engaged in to support debt markets in emerging markets and developing economies.

Deborah Fuhr And I’m Deborah Fuhr from ETF TV, and today we’re welcoming Anderson Caputo Silva from the World Bank. Thank you for joining us.

Anderson Caputo Silva Pleasure to be here. Thank you for the invitation.

Dan Barnes So Anderson, why did the World Bank create the issuer-driven ETF scheme?

Anderson Caputo Silva In the World Bank, one of our key mandates is to support the development of domestic bond markets. The ETF program was designed to support this mandate. It opens access to cost effective saving products and improves competition in financial services. The idea originated from detecting unexploited synergies between our growing industry in the developed markets, and a lack of ETFs domiciled in domestic emerging markets. There are typically hurdles for ETFs in domestic emerging markets. For instance, the difficulty of replicating indices and forming baskets in large amounts, without significant restrictions in secondary markets as these markets are not sufficiently developed. So this leads to smaller ETFs in emerging markets, larger tracking errors, lower liquidity in investor diversification ETFs, and then ultimately investment managers have difficulty in breaking even. And as a consequence, ETFs were very hard to develop. So that sort of originated this name of the issuer-driven ETF and the issuer here we mean, the issuer of the instruments. And then for government that issuer-driven ETF, the issuer is the government, the Treasury. So we work very closely with the Treasury and the Treasury as issuer would have infinite supply of creating the basket of instruments. So we do a feasibility analysis on what should be a minimum size of the ETF at launch. The ETFs is launched as an IPO process and then when the ETF manager sells the ETF units, it has already pre agreed with the Treasury, which is the issuer-driven aspect of it, to provide the supply of the underlying instrument.

Deborah Fuhr So I think the big distinction there is, there is the issuer of the debt instruments, that are underlying the ETF, and then there is an ETF issuer as most of us in the industry would refer to.

Anderson Caputo Silva Yeah, so we work with the government and then we align the development objective of the ATF. And then in this issuer-driven ETF, the government being the supporting entity, supplying the instruments, go into selection process of the potential managers, investment managers for the fund. So the government launches a call for proposals, in the case of Brazil with the asset management, the manager was selected and is managing the ETF that was launched.

Deborah Fuhr How do you decide which emerging market or currencies would be interesting to investors?

Anderson Caputo Silva One of the key aspects of the ID ETF and the role of the bank is to have really a very close linkage between the ETF growth and the development objectives of that country for capital markets. So one of the key first steps is to see this alignment that the growth of the ETF industry would have in helping that market develop. Some of these elements are very natural because ETFs bring price transparency, stimulates liquidity in the indicies. It brings competition in markets that are usually bank centric, when we go to emerging markets. Other aspects are very country specific, fx we look in the case of Brazil, ETFs, where you would have an index-linked to inflation-linked bonds would be fulfilling one of the objectives of the government going in the right direction, that they are trying to reduce indexation through overnight instruments and have longer maturity, inflation linked instruments as part of the portfolio. So those are very key aspects when we try to look at the markets. The other element is that we realize that ETFs, you need some minimum conditions in some markets for this to be successful, and especially in an initiative like this, we want the highest potential of success in creating instruments as we try to replicate to more countries.

Deborah Fuhr So the first product was launched in Brazil. Can you tell us a bit about that product?

Anderson Caputo Silva It was a long journey and we had to help the government and work together with changing tax regulations, even the regulation for fixed income ETF. But the ETF was launched May 21st of 2019. It reached at around 500 million dollars equivalent, which was two billion reais at the time, which made it approximately 10 times larger than the second largest fixed income ETF in Latin America. The other element that we were very happy in observing is that this attracted 2000 retail accounts, 700 of which were for the first time investing in an exchange traded product, in an exchange environment. So this product at the end of last month was about 340 million dollars. But this is largely due to the exchange rate depreciation, because in terms of reais, it’s 2.1 billion, so it’s very large. One of the factors that helped on this instrument was the launch through an IPO process, which is one of the key features of the ID ETFs that allowed the manager to launch at a very large, substantive size. And behind that, there is the support of the Brazilian Treasury in providing the basket.

Deborah Fuhr You mentioned retail investors. Do you find that institutions are also using the product?

Anderson Caputo Silva Institutional investors comprise the largest proportion of the two billion reais. But we saw that this was an instrument that was able to reach both objectives, like attracting institutional investors with large tickets, and also there is a very great access story and investor, like financial literacy being built.

Deborah Fuhr Do you envision you’ll do other products in the future and where might we look to do the next one if you are?

Anderson Caputo Silva In Peru we have signed a collaboration agreement with the government. We are also working in Colombia specifically, but we are also discussing and monitoring other markets.

Deborah Fuhr Thank you for joining us.

Deborah Fuhr Thank you very much.

Dan Barnes I want to thank Anderson for his insights, and of course you for watching. To catch up on our other shows, go to ETFTV.NET or TRADERTV.NET.

Published on July 14, 2020