Asean+3 bond market handbook 1: Market development

EMERGING MARKETS Asean + 3 debt capital markets handbook, May 2011

Chapter 1: Market Development

It is hard to think of a more comprehensive transformation in world capital markets over the last 15 years than the one that has taken place in Asian local currency debt.

According to the Asian Development Bank, the total outstanding volume of local currency bonds in what it calls Emerging East Asia – the main ASEAN nations plus the PRC, Hong Kong and the Republic of Korea – reached $5.2 trillion by the end of 2010, a 13.6% year on year increase. Little more than a decade ago, many of the bond markets that are driving that growth didn’t even exist. “If you look at it from a primary issuance perspective, there is a night and day difference since the Asian financial crisis,” says Roderick Sykes, managing director and head of debt capital markets for Asia Pacific at HSBC.

Indeed, the Asian financial crisis was the catalyst that changed these markets dramatically. “The genesis of the regional collective actions started around 1997-98 after the crisis,” says Sabyasachi Mitra, a senior economist within the Asian Development Bank’s Office of Regional Integration. “At that time, the key lesson of the crisis was – as Alan Greenspan put it – that Asia doesn’t have a spare tyre. He was talking about the bond market.”

A well developed local currency bond market would have given the region better balance of funding, increased its resilience to economic shocks, and allowed its institutions less fickle access to capital. In particular, the currency mismatches that were so exposed in the Asian financial crisis could have been mitigated if Asian borrowers had been able to raise funds locally. “From that time on developing Asia’s local currency bond market became a priority, and they have now emerged as a distinct asset class, a key source of funding for government and domestic companies, reducing reliance on short term foreign currency borrowing,” says Mitra. “And more importantly, they are gradually channeling the region’s vast savings into productive, long-term investment.”

The progress is especially visible in issuance patterns. Sykes, quoting Bloomberg, says that in 1999 total issuance in Asian local currency bonds was the equivalent of US$35.6 billion; by 2010 it was $162 billion, an almost 500% increase. Bloomberg’s figures chiefly track public corporate issues; the ADB, including all government issuance, reckons $3.8 trillion was issued in emerging East Asia in 2010, up 10.2% over 2009.

And the global financial crisis, while difficult for Asia, gave the region the opportunity to show just how much had been learned and achieved in the intervening decade. “What we saw in the recent financial crisis was these markets were able to step up and take up a lot of the slack that was left when cross-border G3, especially US dollars, really shut for many months at a time,” says Sykes.  “Also, the types of transactions that could get done really showed how much these markets have matured.” An example, he says, is the Ps38.3 billion transaction HSBC led for San Miguel Corporation, which raised the equivalent of US$800 million in the middle of the crisis via a domestic deal. “A few years beforehand the largest size you could have seen in that market would have been a fraction of that. We’ve seen similar developments in other markets.”

Mitra agrees that, thanks to successful issues in local currency markets when G3 funding locked up, “Corporates have discovered the vast liquidity and depth in these markets.” And his reference to corporates is in some respects the most important part of the whole story. Building an established government bond market is one thing, but an enduring and accessible corporate bond market is altogether more difficult to achieve. But, as of the end of 2010, total local currency corporate bonds outstanding in the region reached $1.6 trillion – a 20.3% year on year increase driven by growth in the corporate bond markets of Vietnam, China, Singapore, Indonesia and Korea.

A closer look at individual markets in the region shows some interesting differences. The biggest market in the region by far is the PRC, which accounts for $3.1 trillion of outstanding bonds as of the end of 2010, a 15.1% year on year increase (and 37.2% in its corporate bond market) – and this in a market that scarcely existed a few years ago. Several markets in the region logged more than 10% growth during 2010, among them Vietnam (34.2%), Malaysia (18.9%), Singapore (15.9%) and Thailand (14.4%). They represent a range of different stories in progress, maturity and ambition, as a few examples illustrate.

Subhead: The China story

China’s is in some ways the most extraordinary story, given the pace with which it has happened, even as the regulatory environment is still coming together.

“The Chinese domestic bond market has made tremendous progress in the past decade,” says Annie Qiu, head of international business at Citic Securities. “Each year the growth rate has been remarkable.” The industry was given an additional boost by the government stimulus plan in 2009, triggering the highest issuance volume of credit products to date, with almost RMB2.7 trillion raised in various forms.

China stands out for the level of structural evolution that has happened in its market. As Qiu puts it: “The main innovation in this market is related to policy breakthroughs.”

Initially, the only structure for corporate bonds was the so-called NDRC bond – those approved by the National Development & Reform Commission, which had strict limits on use of proceeds and required that the bond be linked to fixed assets. Then a new commercial paper product was introduced into the market by the People’s Bank of China in 2005, followed two years later by a listed corporate bond market, and in 2008 by a medium-term note structure, with a greater flexibility in use of proceeds than the NDRC structures. These bonds can be used for working capital or for refinancing, unlike NDRC bonds, and allow for a set quota of issuance within a two year period.  Last year, new rules appeared for panda bonds: onshore RMB issuance by non-Chinese issuers. China moves ever closer to a comprehensive infrastructure – and even while developing it, has become the biggest local bond market in the region.

The developed markets

At the other extreme are more mature markets in Singapore and Hong Kong. Both have long since emerged as sophisticated funding options for home-grown and international issuers and investors.

“Historically, there were concerns about three limitations in the Sing dollar bond market,” says Clifford Lee, head of fixed income at DBS. “First, the size of offering it could provide issuers; second, the tenor; and third, trading and liquidity.” Lee takes the view that most of these have since been comprehensively dealt with: DBS itself launched a S$1.5 billion perpetual hybrid tier one issue, demonstrating size (other similarly large local currency deals have included issues for foreign companies, such as Malaysia’s Maybank and Khazanah); and the role model in terms of tenor is Singapore’s sovereign wealth fund Temasek, which has issued in steps from 10 to 40 years. It’s true that more could be done on the secondary market, as is the case in many Asian markets, which often lack liquid benchmarks. “As we start going down the credit curve, the market needs to be able to price risk better, and that will take us on to the next stage of our development,” Lee says. But the progress is undeniable. “Onshore issuers who have traditionally looked to the dollar space to raise benchmark-size issues are now seriously considering the S$ market as an alternative. And then foreign issues, from banks like RBS and Lloyd’s to higher yielding names like VTB, are also tapping the market.”

The Hong Kong dollar bond market is among the most developed in the Asia Pacific region.  According to the Hong Kong Monetary Authority (HKMA), total issuance was HK$1,996 billion in 2010, up from HK$456 billion in 2000. Shu-Pui Li, Head of Financial Infrastructure Development Division at the HKMA, says this increase was mainly due to exchange fund bills, notes from the HKMA and the launch of a government bond programme in 2009, but he adds that on the private sector side “we also see some steady growth and we believe that the momentum will continue, in particular driven by developments in the RMB bond market in the offshore RMB centre in Hong Kong.” This extraordinary market is covered in the box within chapter four.

The Southeast Asian revival

One could argue, though, that the most important progress has been made in the markets that suffered most during the Asian financial crisis: Thailand, Malaysia, Indonesia and the Philippines. All are transformed.

“We noted the lack of development in the Thai baht bond market very much during the Asian crisis, back in 1997,” says Khun Thirachai Phuvanatnaranubala, Secretary-General of Thailand’s Securities and Exchange Commission. “It was clear that, without a liquid bond market, financial institutions would find extreme difficulty in managing themselves in a liquidity crisis. So we have been very diligent in trying to develop the bond market here in Thailand.”

The country has been highly successful in doing so. According to Thirachai, the market was worth about US$11 billion, or 11% of GDP at the time, during the financial crisis, yet today is worth $227 billion, and 70% of GDP. “This is a substantial improvement from before the crisis,” he says. “But the problem is that the main part of the growth is still in the Thai government bond market, which accounts for US$183 billion. The remainder, the corporate market, is only about $44 billion. We are hoping that the corporate side could grow a bit more in future – particularly because this will be the area that could help banks with their liquidity.”

In the Philippines – where the peso bond market stands at 37% of GDP, up from 31% in 2000 – Governor Amando Tetangco of Bangko Sentral ng Pilipinas shares Thirachai’s challenge in expanding an often vibrant and mature government bond market to corporate issuers. “The local bond market continues to be dominated by government securities,” he says. “This is something we need to focus on, to encourage more issuance of corporate bonds.”

In Malaysia, the progress has been exceptionally clear, but has come about through a slightly different route. RM143 billion was raised in the Malaysian corporate bond market in the 1990s; RM518 billion in the last decade. “These issuances have provided the critical long-term financing which has enabled Malaysia to undertake many landmark projects and catalytic economic activities, resulting in the country having one of the best infrastructures in the region,” says Tan Sri Zarinah Anwar, chairman of Securities Commission Malaysia. She attributes the growth to a facilitative, disclosure-based issuance framework based on efficiency and transparency, and a well-established legal, regulatory and institutional framework around it. But in particular, Malaysia has built the success of its capital markets on being the regional leader in Islamic finance. In Malaysia’s capital markets, “the sukuk market has emerged as the most vibrant segment, not only in Malaysia but also in the international arena,” she says. Having grown at 21% per year on average over the last decade, Malaysia now has the largest sukuk market in the world.

And in Indonesia, another place where a local currency debt market barely existed at the time of the crisis, national regulator Bapepam points to a series of new initiatives, rather than volume, as demonstrating progress. Chairwoman Nurhaida highlights the introduction of a primary dealer system in government securities, benchmark bonds, mandatory reporting for post-trade activity in all OTC bond markets, mandatory ratings for corporate bonds, bond pricing agency regulation in 2008, improvements in straight-through processing, a shortened issuance process and permission for shelf registration. On top of this has come a host of new products, including government retail bonds, Islamic sukuk and treasury bonds. Almost all of these improvements have happened in the space of the last four years.

The rest of this book will focus on the next challenge: taking that vast improvement in domestic markets and working out how to integrate them. But, as Mitra at the ADB says: “The local currency bond market has now truly emerged as that spare tyre in the domestic financing profile of the national economies.”