Non-residents’ holdings in listed domestic securities have contracted sharply since the pandemic struck nearly two years ago. In particular, foreign investors have scaled down their holdings in Treasury securities and shares listed on the Nasdaq Iceland exchange. Outflows from these positions were part of the reason the Central Bank’s (CBI) net sales in the FX market came to nearly EUR 1.1bn for the period from January 2020 through April 2021.
Foreign investors few and far between in the domestic securities market
Non-residents’ ISK-denominated securities holdings have diminished markedly since the onset of the pandemic and are currently at a low ebb. Sales by foreign investors were concentrated in Treasury bonds in 2020 and equities in 2021. The probability of large-scale outflows from such securities sales is therefore limited, and the likelier scenario is that foreigners will start adding to their holdings once again.
The CBI publishes data on flows relating to non-residents’ new investments dating back to the beginning of 2015, as these investments must be registered with the bank. As the chart indicates, net inflows were relatively strong until mid-2019. At that time, cumulative inflows for new investment totalled ISK 318bn. Since July 2019, however, net outflows have totalled ISK 125bn, and as the chart shows, they were largest by far from mid-2020 through the end of Q1/2021.
In the latter half of 2020, the main difference was in non-residents’ sales of Treasury bonds. According to the spring 2021 issue of the CBI’s Financial Stability report, net new investment totalled ISK 57bn in 2020 as a whole. Of that total, non-residents’ Treasury bond sales came to ISK 51bn. These sales were due mainly to a single large bond fund that held about half of foreign-owned Treasury bonds at the beginning of 2020 but closed out its position during the year. Coverage in the media has identified the seller as BlueBay Asset Management.
After BlueBay’s divestment, the change in foreign ownership of Treasury bonds has been less pronounced, although holdings have been generally on the decline. According to the most recent data from Government Debt Management, foreign investors held just over ISK 40bn in Treasury securities at the end of November. This was equivalent to less than 4% of outstanding ISK-denominated Treasury bonds (ISK 1,020bn) at that time – the smallest total in the history of the data.
Non-residents sold equities in 2021
After BlueBay sold off its Treasury bond portfolio, however, the vast majority of transactions have been due to registered new investments, including non-residents’ purchases and sales of equity securities. According to Financial Stability, net new investment was negative by ISK 58bn in Q1/2021, owing largely to foreign bond funds’ sale of shares in Arion Bank. Actually, that transaction was recently accorded the dubious honour of being crowned the worst trade of 2021 by a panel of judges representing Fréttablaðið Market.
As the chart shows, flows due to registered new investment have been scanty since mid-2021. In fact, Q2 was relatively calm and quiet as well, apart from June, when a foreign fund management company bought a sizeable holding in Íslandsbanki’s initial public offering. Itemised data on outflows due to new investments are not yet available for the period after August 2021, but in view of the data from Government Debt Management, which show only a marginal change in non-residents’ Treasury securities holdings, it can be assumed that a large portion of the ISK 12bn classified as outflows in CBI figures stems from foreign investors’ sales of equities.
Securities accounted for just over a fifth of foreign ISK-denominated debt in 2020
The trend described above can also be seen in figures on foreign obligations in ISK. According to the most recent data from the CBI, which extend through end-2020, these obligations totalled ISK 829bn and had declined by ISK 115bn from the prior year. According to the CBI’s Special Publication no. 14, issued in May 2021, this downturn was due primarily to non-residents’ sales of domestic securities and a reduction in foreign direct investment, as operating losses were recognised as negative reinvested earnings. The same report also notes that at the end of the year, foreign ownership of ISK-denominated securities totalled ISK 172bn, or just over one-fifth of total ISK obligations vis-à-vis non-residents at that time. If the trend described above is any indication, the end-2021 position was probably even smaller.
Foreign inflows both probable and positive
In our view, all of this points in the same direction: Non-residents’ ISK-denominated securities holdings are currently at a low point and have shrunk markedly since the onset of the pandemic. At the same time, the Icelandic equity market has continued to grow apace, and returns on ISK-denominated bonds are much better, on average, than can be found in the rest of the OECD. By the same token, the risk of further outflows due to sales of these assets is relatively limited, and we think it likelier that non-residents will add to their Icelandic securities holdings in the coming term. This would be a good thing because resident entities, particularly the pension funds, invest heavily in foreign securities each year and will continue to do so in the future, as the domestic saving rate is still high.
All else being equal, such reciprocal cross-border securities investment should be beneficial to all parties, especially when it goes hand-in-hand with a relatively well balanced current account, as is expected in the coming term. Increased foreign participation in the domestic securities market enriches the investor base and is conducive to active exchange of opinion in the marketplace, while foreign investment by Icelandic entities diversifies risk. For a small open economy with a relatively small financial market juxtaposed with a substantial stock of long-term savings, this is important.
