recent figures for a bigger sample of EMs and the three developed markets shown in Figure 4.

While the significant ownership shares of foreign investors in a large number of EMs is striking, it is worth noting that even these proportions may understate the importance of offshore demand in certain parts of the market, since offshore ownership is not necessarily evenly-distributed amongst domestic debt issuances. For example, foreign ownership may be concentrated in longer tenors even when overall foreign ownership as a proportion of all debt is quite low, making long-term yields much more sensitive to foreign demand than aggregate holdings data suggest.

Amongst the limitations of the foreign holdings data used for Figure 4 is the difficulty of gauging who the beneficial owners of debt are, given the wide variety of custodial arrangements that exist. The intermediary role of banks, including those with an onshore EM presence, is worth highlighting here; the true extent of foreign investor participation in a market will be understated by basic holdings data in cases where onshore banks warehouse bonds in order to satisfy foreign client demand, or to meet risk management needs arising from their own issuance of instruments, which provide foreign clients with exposure to local yields. The EM credit-linked note (CLN) market has existed since 1996 and as early as 2003 the notional value of all credit derivative contracts based on sovereign EM underlyings was estimated at US$250 billion (including local currency instruments, though these would have been only a small share).<sup>5</sup> Comprehensive market statistics remain elusive, but while the credit derivative market as a whole was hit hard by the financial crisis, it continues to evolve, including for local currency EM debt underlying instruments (e.g. total return swap products replicating local currency bond index returns).

**Figure 4: Foreign holdings of domestic government securities Table 1: Proportion of domestic government securities held by foreigners**

|90<br>% of total<br>% of total|90|**%**|**As of**|**Source**<sup>iii</sup>|
|---|---|---|---|---|
|AU<br>80|Brazil<br>80|12|Q1-2012|JP Morgan|
||Czech Republic<br>|12|Q1-2012|JP Morgan|
|70|Hungary<br>70|42|Q2-2012|National|
||Indonesia<br>|30|Q1-2012|ADB|
|60|Korea<br>60|11|Q1-2012|ADB|
|US<br>50|Malaysia<br>50|27|Q1-2012|ADB|
|HU|Mexico|29|Q1-2012|JP Morgan|
|PL<br> <br>40|Peru<br>40|58|Q1-2012|JP Morgan|
|<br>UK<br>30|Poland<br>30|35|Aug-2012|National|
|ID<br>MY|South Africa|29|Q4-2011|National|
|TR<br>20|Thailand<br>20|12|Q1-2012|ADB|
|KR<br>10|Turkey<br>10|17|Q4-2011|National|
|<br>TH<br>|Australia<br>|85|Q1-2012|National|
|0<br>Jan-02<br>Jan-04<br>Dec-05<br>Dec-07<br>Dec-09<br>Dec-11|United Kingdom<br>United States<br>0|31<br>48|Q1-2012<br>Q2-2012|Bruegel<br>SIFMA|

**Source: National sources (Australia, Hungary, Poland, Turkey); Asian Development Bank (Indonesia, Korea, Malaysia, Thailand); ONS & BOE via Bruegel (United Kingdom); SIFMA (United States)**<sup>**iv**</sup>

The emergence of offshore investors as important participants—and in some cases the single largest investor category—in EMs is an important shift. This trend testifies to the growing relative appeal of EM local currency debt, due to the economic and policy-making progress of developing countries and, more recently, also to the high market volatility and dramatic declines in fixed income yields seen in many advanced economies since the global financial crisis. What is less clear, however, is the direction of causality between local market development and foreign investor participation, and the market impacts of 5 Dates and figures from the British Bankers' Association Credit Derivatives Report (2003/04), cited in Dages et al (2005).

**4**