Thai Repo and Default Swap Markets Slow to Develop
The Thai bond market has become an important point of access to funds not only for Thai corporates, but also for local subsidiaries of multinational corporates enjoying corporate guarantees from their overseas parent company. In recent months, local subsidiaries of Ford, Tractebel, Nestlé and Unilever have all tapped the local markets and more issues by the local subsidiaries of international companies are planned in the near future. By the end of 2002, the outstanding value of domestically issued corporate bonds had risen from Bt177 billion in 1997 to Bt543 billion, whilst the overall value of the market (including government issued bonds and T-Bills) over the same period had increased from Bt546 billion to Bt2,300 billion. The regulations relating to bond issues were revised in October 2001. Most bond issues are now subject to disclosure requirements (ie, the filing of a draft prospectus and registration statement) which must now be approved by the Securities and Exchange Commission and must be rated by one of the two authorised rating agencies in Thailand.
In December 2000, the Bank of Thailand (BOT) announced new regulations permitting financial institutions to undertake private repurchase agreements between such institutions. The underlying products that can be traded were limited to government issued or guaranteed and state owned enterprise’s securities. The Task Force established by the Ministry of Finance and the Thai Bond Dealers Club recommended that products be traded based on The Bond Market Association and International Securities Market Association’s Global Master Repurchase Agreement, for which they commissioned the drafting of a Thai local annex. The BOT hoped that, by permitting repo trading on a private bilateral basis, it would increase the liquidity of the sovereign debt market, but to date market participants have been slow to commence trading. Market participants have been slow to reach consensus on documentary standards for private repurchase agreements although it is anticipated that the first trades will occur in the first quarter of 2004. The BOT is encouraging the private repurchase market as a way to inject or withdraw liquidity from the market.
The BOT passed new regulations in June 2002 that permit banks to enter into a credit linked note transaction. This is defined as “a transaction under which a lender or buyer of an instrument has entered into a contract with a borrower or an issuer of the instrument and agrees to accept the transfer of credit risk of the debt instrument or the reference asset, issued by a third party. In return, the borrower or issuer agrees to pay the lender or the investor a return reflecting the credit risk of the debt instrument or reference asset.”
Banks are required to maintain ownership of the underlying reference assets throughout the life of the credit linked notes (CLN) and the remaining term of the reference assets must not be less than the term of the CLN.
The type of counterparty with whom banks may enter into CLNs remains limited to domestically incorporated banks, domestically incorporated finance companies, financial institutions outside Thailand and special purpose vehicles incorporated outside Thailand and especially specifically for the purpose of entering into CLN transactions. However, investors remain concerned as to certain aspects of the guidelines and that certain regulatory costs may impede market development.
In May 2003, the BOT continued the development of its policy to expand slowly the range of derivative type products banks might enter into by approving credit default swaps (CDS). A CDS is defined by the relevant Notification as a “purchase or sale of an agreement providing for guarantee against credit risk of an underlying asset as stipulated, under which a purchaser agrees to a pay a fee to a seller and a seller agrees to pay an agreed sum upon the occurrence of a credit event”.
The Notification states that purchasers of a CDSmust maintain a capital fund capable of absorbing the credit risk of the underlying asset and that the underlying credit selling the CDS protection must be credit rated.
Whilst some market participants have started to review the potential benefits of CLN and CDSproducts, to date the market has not really commenced. New reporting regulations are being implemented in November 2003 which will require banks to report specifically both CLN and CDStr ansactions to the BOT within seven days of the end of each month. Therefore, clearer market data should become available in the near future. In the meantime it is hard to envisage a liquid market of banks selling and purchasing credit risk to mitigate over-exposure to certain sectors or credits or managing single lender limits or exposures through the use of CDSbec ause, in general, banks that would be buyers of credit protection are hungry for assets in a highly liquid domestic environment. In addition, investors who would be natural sellers of protection do not have clear guidelines and also require regular and transparent price quotes for valuation purposes.
Nick is an associate in our Bangkok office. His practice includes advising on various capital market products including commercial paper programmes, bond issues, repos and derivatives.