Investors hunting for better yields amidst rock bottom rates in established markets have caused the amount of emerging market corporate debt in the global market to explode. Jay Tambe, partner at Jones Day, said the repercussions could be massive and painful.
Emerging market corporate debt has skyrocketed from $4 trillion in 2004 to more than $15 trillion, according to the International Monetary Fund. As for where the majority of the issuance is coming from, Chinese corporate debt alone makes up more than 60% of the amount.
"These were attractive places to invest and it was relatively easy for companies in that part of the world to raise debt without paying a lot in interest rates," said Tambe. "It was an attractive proposition for both issuers and investors."
Nevertheless, Tambe said he expects the number of corporate credit defaults to start snowballing as emerging market growth in China and Brazil stumbles while corporate profits and commodity prices slide. Also not helping is the fact that huge tranches of dollar-denominated debt are falling due, against a backdrop of falling local currencies and higher U.S. interest rates.
Tambe said creditors and investors including financial institutions, pension funds, asset management firms and hedge funds with high-yield and emerging market debt exposure will experience an impact. In his view, the scale of the problem could potentially lead to another global financial crisis.
"You do have a fair of dollar denominated debt that has come out of China so it might seem like an obvious answer to devalue your currency to help pay off your debt, but maybe not. If you have a lot of dollar denominated debt, that's a problem," said Tambe.
As for U.S. investors worried that they may be affected by bad emerging market debt, Tambe advises them to find out what they own because emerging market debt pops up in a lot of bond funds.
"You'd be surprised as to where emerging market and China debt shows up," said Tambe. "It shows up in a lot of different types of bond funds. There are some that are specifically focused on the emerging markets but even broader bond funds have higher yielding debt from a lot of the emerging market countries."
Once they find out if emerging market debt is indeed in their portfolio, then investors can decide if they want to take the risk of owning it.
"It is a risk and it's a growing risk in our view," said Tambe.