* JP Morgan to change widely-followed EM indices
* Changes will benefit bigger countries
* Smaller sovereigns likely to suffer
By Michael Turner
LONDON, Sept 15 (IFR) - Some of the most indebted emerging market borrowers are expected to see pockets of demand for their bonds soar almost overnight, after JP Morgan implements changes to the methodology of its widely-used indices.
The US bank will shift how much weight it gives to different issuers within key emerging market indices, with the rebalancing set to take place between September 30 and November 30.
Larger sovereigns with bigger index-eligible debt piles will now constitute a bigger slice of the index - at the cost of smaller countries.
This could have wide-ranging impacts on emerging market debt, as a bigger index presence will see more money flow into those bonds through passive funds, supporting secondary market prices and encouraging primary market issuance. The opposite is true of countries that see their positions in indices slashed.
“The effect is potentially quite sizable,” said an emerging market bond trader. “Passive funds have to track the index, so if a weighting goes up, there will be overnight demand for that debt.”
An emerging market debt analyst added that passive investors will have to rebalance their portfolios, with money forced to move out of the names that have had their weighting reduced.
JP Morgan said in a note that the weightings of its key diversified emerging market indices - the EMBIG, CEMBI, and GBI-EM - had “significantly deviated” from the underlying debt stock of their constituents.
These indices will now weigh countries in the indices relative to other index participants, with the maximum weighting for any single issuer capped at 10%, which JP Morgan said aims to “preserve the right balance between reducing risk and reflecting the true profile of the market”.
The EMBIG covers hard currency bonds from sovereign and quasi-sovereign issuers, the CEMBI measures hard currency bonds from corporates, while the GBI-EM is a local currency bond index.
The methodology change has big ramifications.
Sberbank analysts note that while the Philippines and Mexico have roughly the same weighting in the old index, under the new methodology the latter will be “more heavily weighted in the index”.
This reflects the fact that Mexico has US$80bn of index-eligible debt compared to just US$22bn from the Philippines.
Mexico’s representation in EMBI Global Diversified index is expected to soar from 4.21% at the end of July to 5.76% when the new rules are implemented, with Russia, Venezuela, Turkey and Ukraine also expected to increase.
In the CEMBI Broad Diversified index, China, Brazil, Russia and Mexico also stand to gain ground, with China’s share expected to rise by 329bp to 8.37%.
Kazakhstan is one of the biggest losers in the EMBI-GD and CEMBI-BD rebalancing, with the sovereign’s weighting expected to be cut by 19bp to 2.79% and 30bp to 0.81%, respectively.
JP Morgan is also slashing the minimum required maturity for bonds to be eligible for the CEMBI (narrow) index to 13 months from 37 months. This will not be retroactively applied.
“The move would support longer-dated issues when they near this duration,” said Sberbank. “In the past, local investors would have been the only active buyers in this type of paper.”
Meanwhile, Nigeria will be phased out of the local currency GBI-EM index series by October 30, 2015.
“Foreign investors who track the GBI-EM series continue to face challenges and uncertainty while transacting in the naira due to the lack of a fully functional two-way FX market and limited transparency,” JP Morgan said in a statement.
Nigeria will not be eligible for re-inclusion into the indices for a minimum of 12 months.
A JP Morgan spokesperson declined to comment on any of the changes. (Reporting By Michael Turner; editing by Sudip Roy and Robert Smith)