True to its reputation for intransigence, North Korea has made no signs of wishing to start repaying or rescheduling its debt. But such defiance hasn’t prevented its debt prices rising by 15% on long-shot speculation that North and South Korea could reunite and as a result of generally positive sentiments on emerging markets.
Quick off the mark has been Banque Nationale de Paris (BNP), which last month issued the first tranche of its vehicle for turning North Korean debt into a tradeable bond under the name of NK Debt Corporation.
This vehicle promises to solve some of the settlement problems associated with North Korean debt, of which BNP is itself a significant holder. The bond has been well received by investors even though it is not clearable through Euroclear.
At the end of 1996, North Korean debt was trading at a 20% discount to face value, which has since soared to 35% and could well go higher, say market watchers. The amount of debt covered by the BNP bond issue is now one-third of the $800 million outstanding.
“BNP is issuing this bond first and foremost for commercial reasons, but the broader objective was also to create a cost-efficient, liquid market in this debt. It used to be very expensive for smaller investors and BNP wanted to cut costs,” says Peter Bartlett senior vice-president at BNP.
Bradley Wickens, economist at Banque Indosuez, says: “The one big problem with this BNP vehicle is that it’s not clearable through Euroclear, which is owned by the US company Morgan Guaranty. This cuts out 80% of potential buyers.”
Claire Saunders, responsible for new issues at Euroclear, says: “We look at new issues on a
case-by-case basis. The documentation for this issue came into our offices extremely close to the issuance date and, after noting the restriction on US persons dealing with North Korean assets, we decided we would not take it in.”
Using the BNP vehicle does not come cheap. People holding North Korean debt will have to pay BNP a premium equal to the market difference between the underlying debt and the transferable participation certificates (TPC) issued by North Korea’s agent, (in this case ANZ Banking Group), in order to transfer their TPCs into a share of the bond issue.
“The reason only a third of the debt is being put into this vehicle is because BNP is charging between one-quarter and three-quarters of a percentage point, depending on the size of your holdings, to let you use the
vehicle,” says Wickens.
The North Korean bond will undoubtedly make the settlement process much easier for buyers and sellers. “It used to take 15 days to close a deal and would involve the agent, buyer, seller and original lender. It would cost between one-eighth and one-half of a point in costs per transaction,” says Bartlett. “It was also necessary to pay a fee to both the agent and another to the original lenders in order to get yourself re-registered.”
With the current upward trend in debt prices, long-term holders may prefer to hold on in the hopes of still higher prices. But the vehicle does make it more cost-efficient and convenient for people who wish to trade in North Korean debt.
“As time goes by, debt holders who haven’t committed to the vehicle will start to approach BNP to jump on the bandwagon,” says Bartlett. “There are increasingly more investors and also more original holders of debt who are willing to give debt to BNP’s vehicle.”
In addition to the fee generation, BNP hopes to make money by capitalizing on a more liquid market as well as being a market maker in the new instrument.
The bond has been quite successful. “We have already issued the first two tranches, one denominated in Deutschmarks, the other in Swiss francs, of approximately Dm300 million, and we are anticipating issuing another two tranches immediately and further tranches over the next months,” says Bartlett.
North Korean debt has benefited from improved relations between North and South Korea. US sanctions on North Korea may soon be questioned. BNP’s vehicle is certainly taking advantage of widespread speculation about reunification of the two countries. “It’s an opportune moment,” says Wickens.
In the past, North Korea has been unusually defiant over paying back western banks, but Bartlett agrees that “if they reunite, the price of North Korean debt will go up very fast. There is the precedent of east and west Germany, where the debt of the former was paid off by the latter.”
Until then, creditors and holders of the debt are still obliged to share, pro rata, the legal costs of ensuring that North Korea continues to recognize its obligation to pay back the debt. Katrin Fhima
