Paving the Way for a Regional Asian Debt Market
The Asian G-3 bond universe is small and the tradable size of the market is even smaller. Most investors in domestic currency bonds are the region’s insurers and the pension funds who tend to buy and hold. This translates in minimal activity in the secondary markets.
But things are about to change as many of the region’s governments put substantial monetary backing in the form of a second bond fund into the creation of a sustainable regional debt market.
But whether money alone will do the trick remains to be seen. Cross-border investors have shied away from the under-developed domestic bond markets in Asia because of a lack of liquidity. “Because we have dedicated fund managers, we know where the liquidity is. For some people, it becomes a barrier. I think in all cases, we have to be cautious,” says Rod Davidson, global head of fixed income at Aberdeen Asset Managers.
Sean Flannery, senior principal of State Street Global Advisors, says: “If you’re talking about investing in Asia, it’s really transparency or liquidity.” He manages over US$300 billion in fixed-income and cash assets for SSGA globally.
Some investors propose credit enhancement for less credit-worthy issuers to be introduced in the future, in order to make the bonds more appealing to investors. One way would be to have bank guarantees, for example, having issues guaranteed by either Asian Development Bank or International Finance Corporation.
But a fund manager with a Japanese asset management firm, who was attending a conference in Bangkok on the Asian Bond Fund, has his doubts: “It’s a good idea to have credit enhancement facilities. But seriously, do you think anybody is willing to provide guarantees for onshore issues?”
Another banker believes the answer might be to pool funds in the regions to create a bigger infrastructure. Illiquid markets such as Indonesia and the Philippines will then be able to set benchmarks with the help of the more developed markets like Hong Kong and Singapore. Investment in the Asian Bond Fund could also see an increase in liquidity, and with private sector companies coming in; issuance will also be likely to increase.
“For the Asian bond market concept to take off, we need a stable infrastructure, good clearing and settlement system, qualified issuers and investors, market liquidity and lastly, a benchmark yield curve,” says Chakkrit Parapuntakul, director of the international finance bureau, and arm of Thailand’s Ministry of Finance’s Public Debt Management Office (PDMO).
Issuing bonds to raise capital became popular in Asia only after the financial crisis in 1997. Before that, bank borrowing was the norm for most corporates. But the collapse of local banking systems that had both triggered and resulted from the regional crisis in a vicious cycle of cause and effect led to a sober re-think of that traditional practice.
The domestic bond markets are providing an alternative source of funding for onshore companies which sought to expand further. Thailand took the first step to propose the idea of financial integration to the rest of Asia – a robust regional bond market concept where money in Asia should be poured internally to fund infrastructure projects and not feed the coffers of the more developed Western economies. With regional initiatives in place, the concept of the Asian bond market concept looked set for a jumpstart with almost the whole of Asia wound up at its inception.
The governments behind the bond fund initiative hope to encourage Asian countries and companies to invest in the Asian markets, encouraging money to stay. But there are heaps of regulatory and legal obstacles that both investors and issuers would have to overcome.
If the problems can be sorted out, regional corporates will be able to rely broaden its investor profile. “An Asian bond market will provide us with another platform to raise funds,” says Raja Sulong Razak, general manager of Bumiputra Commerce Bank Bhd based in its Singapore office. The bank had just recently issued a debut US$300 million subordinated bond which was priced at a discount to yield 5.182%.
“It would certainly affect our decision to raise funds in the future. The debt profile that we will gain will be beneficial to us in the long run if we were to access the market,” says Ratthaphol Cheunsomchit, director of business development at Gulf Electric Public Co Ltd whose company has all along used project finance to develop their power generating business.
The realization of an integrated Asian market may be a long way away. “We don’t have a consistent settlement system, some countries still have restrictions on local investors buying foreign debt, and of course, there is still the withholding tax issue to deal with,” says Dominique Dwor-Frecaut, director of Asian research at Barclays Capital.
As one conference delegate was overheard saying rather loudly over coffee break: “This [bond market concept] will not take off because Asian countries can never agree on anything.”
But some governments at least are trying. Thailand, for example, removed its long-standing withholding tax law in September this year in support of the bond market.
Getting all the countries involved to do away with withholding tax may not be at once possible. But private sector companies and investors can definitely feel the full weight of the support when it’s finally done. Currently, taxation for bonds varies across Asian nations. With the exception of Hong Kong, all other Asian countries charge withholding tax. Even so, Singapore has attracted a large number of foreign issuers to its domestic bond market due to a liberal tax regime, by rewarding qualified debt origination houses with tax incentives.
Investors will also have to contend with currency risk if initial outlay in the Asian bond market is placed not just in US$-denominated issues, but in a basket of Asian currencies. “With proper hedging instruments, Japanese investors can probably invest in rupiah and hedge it back to yen. That’s really a healthy development in the market, the risk is evenly spread,” says Darcy Lai, managing director and head of dept capital markets/investment banking of Asia Pacific at Barclays Capital.
“Japanese investors are very interested in the Asian bond market concept and are interested in investing in it as an alternative to the domestic stock market,” explains Naoyuki Yoshino, professor of economics at Keio University in Tokyo. “Currency fluctuation will not be a problem as long as there is a proper hedging platform in place.”
However, hedging costs remain high in Asia and there is also a lack of liquidity in the derivatives market. According to Dwor-Frecaut, Asian countries should do better to remove restrictions on access to local currency funding, onshore forward forex market and onshore derivatives markets to non-residents.
With proper hedging instruments, currency speculation can be minimized. “At the end of the day, currency matters. Asian nations will have to work it out sooner or later,” says Fan Jiang, director of Asian credit research at Goldman Sachs in Hong Kong, referring to one key element in developing an Asian bond market.
The role of the three international ratings agencies – Fitch Ratings, Moody’s Investors Service and Standard & Poor’s – is also seen by some as limiting the development of an Asian bond market. The international ratings agencies have often been criticized as being weighted towards Western credits. And if Asian names are rated internationally at all, there is a perception among regional market players that those were mostly the bigger credits.
A proposal is being discussed that an integrated regional rating agency that will focus on smaller and medium-sized companies in Asia should be set up.
“There is a need for a regional credit rating agency to unify rating methodologies within the region,” Dwor-Frecaut says. “And once that’s done, it’s also good to have a ratings rotation policy – companies to be assessed by a different ratings agency every two to three years.”
Most countries in the region have their own local credit bureaus which makes it hard for standardized ratings across the board. Fitch Ratings (Thailand) and TRIS operate in Thailand while RAM and MARC rate local companies in Malaysia. South Korea has agencies affiliated with Fitch and Moody’s, and in Indonesia, local ratings agency PEFINDO is related to S&P. The Philippines Ratings Service Corp covers companies in the Philippines while China is supported by the international agencies. Even in Japan, there is the Japan Credit Agency while India, who will participate in the second ABF, has CRIS and ICRA to do the work.
It may take years for the dream of a regional credit bureau to materialize, as cultures among Asian countries are very different. Rating methodologies are uneven and this will ultimately cause problems in rating local companies’ foreign-currency debt.
Some bankers also spoke of the danger of political pressure being put on investors to put money into issues for the sake of patriotism. Others disagree.
“Firstly, we have our commitment to shareholders. Of course, if there is a good opportunity, we will go for it. But we are certainly not a charity organization,” Dwor-Frecaut says.
“Put it this way: There are two bonds you can buy – one in country A and one in country B – both with similar risk and return profile. But in country A, if there are significant constraints, then they would have to pay a premium,” adds Flannery.
However, as in the case of central banks in Asia, one cannot deny their main roles and functions. Will it be prudent management on their part to buy Asian bonds instead of say, US Treasuries even though returns are certainly going to be better? In other words, is it worthwhile to sacrifice minimal credit risk just to keep money invested within Asia? It’s anybody’s guess.
Hong Kong and Singapore have highly developed domestic bond markets. And Thailand developed its domestic bond market after the financial crisis in 1997 when the baht was heavily devalued.
“We need the more advanced countries here to play bigger roles, like in the case of France and Germany bringing together the Euro market,” Dwor-Frecaut says.
The chairman of Barclays Group, Sir Peter Middleton, further stressed the few elements that are essential for the success of the regional bond market concept: accounting transparencies, a robust legal framework, liquid benchmark yield curves, good pattern of savings, convergence of various countries’ financial workings, common understanding of tax workings, and ultimately attracting more foreign issuers to tap the market in Asia.
The first Asian Bond Fund (ABF) advocated by members of the Executives’ Meeting of East Asia Pacific Central Banks (EMEAP) was basically formed to bring back Asian reserves that are traditionally being held in the Western economies.
The 11 members of EMEAP, which included Bangko Sentral ng Pilipinas, Bank Negara Malaysia, Bank of Indonesia, Bank of Japan, Bank of Korea, Bank of Thailand, Hong Kong Monetary Authority, Monetary Authority of Singapore, People’s Bank of China, Reserve Bank of Australia and Reserve Bank of New Zealand, pooled a sum of US$1 billion to invest in a basket of US$-denominated bonds issued by sovereign and quasi-sovereign entities of the EMEAP economies (excluding Australia, Japan and New Zealand). The fund was launched in June this year and is currently managed by Bank for International Settlements (BIS).
Figures from reports revealed the amounts invested by some countries – Thailand contributed US$120 million to the fund, while South Korea invested more than US$100 million. Japan, Singapore and the Philippines pooled US$100 million each, while Australia and Indonesia put in US$50 million each. New Zealand invested US$25 million.
“The creation of the ABF is a much bigger event than it might look,” says Sir Peter Middleton, chairman of Barclays Group, emphasizing the importance of the fund. The EMEAP Group had all along played the role of financial intermediation in the region and launch of the ABF was to facilitate the channeling of a small portion of the very sizeable official reserves held by the Asian economies back into the region. Skeptics, riding on this thought, chose to argue that the sum of US$1 billion invested into the fund was nothing compared to the foreign-currency reserves held by Asian nations and invested in US Treasuries among other securities.
However, as analysts put it, central banks and monetary institutions in Asia were merely acting as catalysts, to start the ball rolling. Ultimately, private sector companies and willing investors will have to walk the rest of the journey. In fact, as revealed by Joseph Yam, chief executive of Hong Kong Monetary Authority, private sector companies would be able to invest in ABF II, even as early as in the next six months when details and structures are finalized. One other important aspect; the fund would be invested in issues denominated in Asian currencies.
Dominque Dwor-Frecaut, director of Asian research at Barclays Capital, says: “The most important contribution from the public sector is definitely not money, but political support. The second bond fund will help create diversity by bringing in private investors, and this is with the full support from regional public institutions.”
With the launch of ABF II, governing authorities hope to make Asian bonds a distinct asset class of its own and thus create a much deeper ABM. “As long as the Asian investor base remains fragmented, the more we need to develop the Asian bond markets,” says Koh Yong Guan, managing director of Monetary Authority of Singapore.
One can see that the ABF is essentially more than a symbolic gesture into creating initial demand to fit with the bigger jigsaw piece of the ABM. Central banks and monetary authorities in the region have taken the initiative to pool funds together in the hope of getting private sector market players immersed in the ABM for the long haul.