The Important Role of the Market for Debt Securities

In OECD countries as a whole, credit is the central element of economic activity as indicated by the size of the inventory over total gdp. The share of the banking sector is significant, but the share of credit generated in the capital markets is even larger.

Capital markets-based financing appears to thrive and seems consistent with significant and credible democratic processes. Debt securities sold to investors demand a different type of conversation, in which the terms of the contractual agreements, commitments and obligations of the parties involved are more balanced—investors placing their trust in a transaction no longer need to do so based purely on personal connections. Rather, a given transaction would be a business proposal, a project or a cash flow, presented to investors in a conversation in which there is no certainty of the outcome in advance and the price is not fixed by a dominant party, such as a bank, in a market where alternative means of accessing financing are scarce.

The process of financing through a debt security is, in a sense, a voting process (although one in which voting powers are unequally distributed). It implies disclosure, transparency of information at inception, the obligation for information to be available throughout the life of the transaction and a set of clauses designed to manage problems, delays, and potential default. Credible enforcement agencies are necessary to convince both investors and borrowers seeking an alternative method of financing their projects. This is very clear with respect to the market for government bonds, where a government’s misbehaviour is punished by an increase in the cost of borrowing and a loss of legitimacy, even if that government does not face the test of an imminent election. It is also one reason why many governments prefer to borrow internationally rather than expose themselves to the judgment of domestic investors and credit markets.

In general, bond market growth assumes a level of financial and accounting disclosure, which is necessary for the credibility of the interest payments that the transaction promises to deliver to the subscribers. This exchange of promises backed by sufficient financial and legal documentation from the issuers, and the delivery of accounting and financial tools to the investors in order to convince them first, and encourage them to increase their investments in existing or new issues, is effectively based on many elements of democratic processes and governance frameworks. Agreements of trust between people with no previous connection are able to expand, mirrored by the bond transactions representing this trust. The price of these bonds at inception, and the evolution of that price through independent actions of selling or buying units of the bond issue indicate the reaction of people with no previous connection to the issuers and assess the level of trust that these people have. This is a typical example of capital market voting behaviour, implying independent decisionmaking based on required information, disclosure, transparent price fixing and access to the mechanisms of investing or divesting, buying or selling in an anonymous process.

The growth of credit through the issuance of bonds is therefore an important development; it encourages behaviour and expectations within the economic sphere, which can support the transition towards more democratic behaviour in the political realm. It allows the number of participants in economic activity to increase. The trust and links are no longer between previously connected parties, allowing the number of conversations and growth impulses to increase. Increasingly available and accessible credit fosters economic expansion.

 
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