Emerging Markets Asean + 3 bond market guide

Emerging Markets, June 2012

Asean+3 bond market guide

Section One: The markets and integration

Ever since the Asian financial crisis of 1997-8, work has been underway to bolster Asia’s local currency debt markets, so as to make sure that the biggest challenge of that era – foreign currency exposure – is never a systemic threat again.

Judged purely by the scale of individual markets, there has been clear success. Total bond market size among these economies has trebled since 2003, and has been on a particularly strong trajectory since the 2008 financial crisis, with outstanding local currency bonds from emerging East Asia growing by an average of 15.1% over the last five years, according to Asia Bond Monitor, a publication backed by the Asian Development Bank. By 2011 total local currency bonds in the region, not including Japan’s developed and mature markets, had reached US$5.7 trillion. The share of world bond markets from this area has now reached 8%, well above, say, 2.5% from the UK or 4% from Germany.

The problem is, while these markets are growing fast individually, flows between them are still small. Asean markets are ever more connected from a trade perspective, and the supply chain among them (and in particular into China) is increasingly sophisticated. But those patterns are just not mirrored in the capital markets. ADB data suggests that the share of cross-border debt investment as a percentage of the region’s total stood at 7.2% in 2010 – up from 4.2% in 2001, but still a low number. Largely, when investments leave Asean+3 countries, they go not into neighbouring currencies but dollars.

That is regrettable, because the benefits of harmonized and integrated bond markets would be great.  Success would create a much larger scale of overall market, increasing efficiencies, reducing costs, and diversifying funding sources.

They would also address a perplexing oddity of Asian funding: the mismatch between vast savings and enormous needs for investment. If money went straight from one to the other, all of Asia would benefit.

Sabyasachi Mitra, senior economist in the Office of Regional Economic Integration at the ADB, speaks of “the whole paradox here that Asia has huge development needs in physical and soft infrastructure, and it is home to the largest savings in the world – yet are we using regional savings for regional investment needs? We are still intermediating through the global financial centres. Why are Asians not investing in Asian markets for long term finance?”

Increasingly, those in the private sector agree. “Almost every country in Asean+3 has realized that dependency on dollars is costly,” says Lee Kok Kwan, deputy chief executive officer, group treasury and investments, at CIMB. “Local currency bond markets, as they develop, will certainly take away a lot of these systemic dollar liquidity risks and reduce the concentration of domestic credit risk on the banking system. For Asean + 3, this dependency is highly unnecessary as the savings rate is 20 to 50% of GDP.”

It was in 2003 that the Asian Bond Markets Initiative was founded, seeking to improve and bring together the bond markets of the Asean + 3 member countries: the 10 Asean nations plus China, Japan and Korea. But with an initial focus on strengthening individual markets, it’s only lately that attention has turned to this next phase of integration. The meeting of Asean+3 Finance Ministers in 2010 was a key event; that year the joint ministerial statement pledged to explore ways to promote cross-border bond transactions, in order to mobilize regional savings for regional investments and so sustain the region’s economic growth.

Integration is not easy. There is no single currency like in the EU, nor any supranational body that looks like the European Commission. The region covers an extraordinary range of cultures, languages, political systems, legal codes and market practices, from currency-restricted China to free market Singapore. A study published in 2010, the ABMI Group of Exports report, illustrated the problem. It found that cross-border bond transaction costs in the Asean+3 region were on average three times higher than those in the US and the EU, with major variation between markets;  it also came up with an ominously long list of major market barriers, from technical issues such as messaging standards and securities numbering, to regulatory issues such as foreign exchange controls, foreign investment quotas,  differing registration processes and prohibitive taxes.

The integration debate is rich in abbreviations and forums, committees and meetings, if not always in practical progress. Under the Asean + 3 Finance Ministers group, and their deputies, comes an ABMI Steering group, which overseas four task forces: one to promote issuance of local currency bonds, one to facilitate demand for them, one to improving the regulatory framework, and one to improve the related infrastructure for the bond market. The Asean + 3 Bond Market Forum, approved in May 2010 and launched in September 2010 as a common platform to help bring about standardization of market practices and harmonization of regulation around cross-border transactions in the region, falls under the third of those task forces. It also aspires to act as a nexus between Asean + 3 and the rest of the world when it comes to international standards and rules, and to engage the private sector.

The ABMF recently completed phase one of its mandate, the main output of which was a comprehensive (really comprehensive – the PDF runs to 1,532 pages) guide to regulatory frameworks, market practices and infrastructure in the Asean+3 bond market.

What next? Tetsutaro Muraki, CEO of TOKYO AIM, who is chair of the ABMF’s sub-forum 1 (the one responsible for comparing regulations and market practices across the region;  sub-forum 2 handles transaction procedures and bond messaging formats to enhance straight through processing) explains. “In phase two, we want to take a step further and to understand in more detail from the practical perspective what are the current regulatory standards and what issues could affect the harmonizing of the cross-border regulatory environment,” he says. This will involve consultants going to the member economies and coming up with an analysis to focus on cross-border harmonization.

One might wonder what has been going on for the last 10 years of harmonization initiatives if this is where we are today, but Muraki feels that “now [the region] is much better suited or harmonization. The level of the economies in Asean today is very different to 10 years ago. Take Thailand: 10 years ago it was recovering from the Asian crisis, now it is a very wealthy trade surplus economy. We still have economies like Cambodia and Laos, but generally the ground is much better set for harmonizing.” Taking the next step will be challenging, he says, and is not something he feels it useful to put a date to. “It would be best if we could say we were going to harmonize all the economies on the region on X day, say two years from now, but realistically that’s going to be very challenging,” he says. So one practical answer is to start building bilateral agreements in the hope that over time they become multi-partite agreements, and eventually a harmonized regional framework.

And bilaterals do happen, paving the way for greater cooperation. A clear example here is the work between the Hong Kong Monetary Authority, Bank Negara Malaysia and Euroclear Bank, whose pilot platform for cross-border investment and settlement of debt securities became operational on March 30 2012 following years of work by a task force set up between them in 2008. This platform seeks to strengthen cross border issuance of, and foreign investment in, local bonds in Hong Kong and Malaysia. Through the platform, investors in both can buy and hold foreign debt securities and settle cross-border transations on a delivery-versus payment basis. The platform also includes a comprehensive debt securities database of Asian debt securities maintained by Euroclear.

Peter Pang, deputy chief executive of the HKMA, calls it “a strategic alliance that goes much beyond commercial cooperation and will bring about more significant benefits in fostering global and regional bond market development as well as promoting financial stability in the region.” And Muhammad Ibrahim, deputy governor of Bank Negara, calls it “a major milestone for regional financial integration, and a step towards a unified bond platform across Asia.”

All three institutions say they plan to try to promote the platform to other central banks and securities settlement systems in the region, making it very much the sort of bottom-up, bilateral-first platform that Muraki and his colleagues want to see.

The other ABMF sub-forum tries to enhance regional straight-through processing by harmonizing transaction procedures and message formats. The idea here is to get to a point where any cross-border transaction can take place without any manual processes between the two systems involved along the way.

This is a bigger deal than one might think. Constraints include not only language but the characters of those languages: Chinese characters and Thai letters need to be converted into alphabets in order to execute a cross border transaction. The ADB says this could be mitigated if all transactions were executed under the International Organization for Standardization’s new ISO20022 standard, which incorporates technology that can process different national letters and characters. There is also a hope that, by increasing competition among financial telecommunications networks, cross-border transaction costs could come down. “The region needs a more efficient and cheaper money- and securities-transfer system for more integrated and harmonized financial markets,” the ABMF guide says. “By clarifying various cross-border transaction procedures and enhancing STP, the costs involved in cross-border transactions can be reduced.”

How to harmonize? There are two ways of doing it: top-down, in which rules are set and then applied downwards to all countries, as is the case with the Eurobond market under the International Capital Market Association; or bottom-up, one at a time. This latter approach brings in another body, the Asean Capital Markets Forum, which has been trying to build the Asean and Plus Standards, which set common harmonized standards for Asean as a starting point.

With harmonization clearly a challenge between jurisdictions, there is increasing interest in the idea of a Eurobond-like offshore market, one that isn’t domiciled anywhere and is largely self-regulated. This was one of the Sub-Forum 1’s key findings in its report. One way this could be done is to focus on private placements, creating a professional marketplace populated only by qualified investors. “The key outcome would be an organized, well-documented common regional private placement market,” the sub-forum says. Another aspiration is a common regional medium-term note program within jurisdictions that are committed to opening up their markets to qualified issuers and investors.

Some argue that the sovereign crisis in Europe created a spur for integration. “The sovereign crisis and low interest rate environment in the developed world resulted in global investors shifting their investment focus to emerging markets, and Asia in particular,” says Wan Kamaruzaman at the Employee Provident Fund in Malaysia, one of the region’s key institutional investors. “This diversification away from the major economies and their currencies has somewhat escalated the progress of the local bond market and the integration of the Asean + 3 bond market.” One might argue that the appearance of modest capital controls in the region undermined that, but Wan feels “these are basically short term measures aimed at stabilizing the markets. In the long run, everyone is aware that developing and deepening the bond market is crucial to the financial stability of their respective markets.”

Wan says he has seen “significant progress” at central banks and other regulators in their efforts to integrate. “However, what is still lacking is the participation of the private sector with quality issuances that will help create liquidity and deepen the bond market, particularly cross-border issues.” The EPF itself tries to support cross-border issues if they meet the institution’s investment criteria. In May 2011 it introduced an absolute return mandate in the local bond market, to create liquidity in the corporate and government markets. “A liquid domestic bond market will have positive spillover effects to other regional bond markets.”

The region’s bankers are keen to see greater standardisation and are quite clear on what they want. “FX regulation is a big one,” says Clifford Lee at DBS. “Then there is regulatory relaxation, first and foremost to take away withholding tax restrictions, and secondly to allow for easier access to local capital markets.” It would help if, Asean aside, bigger neighbours relaxed currency restrictions too. “The two huge markets, India and China, are still restricted in how you can access them,” says Lee. “You can’t freely invest into them, let alone do issuance and swap back out.”

“I’m cognizant of the fact that getting everyone to relax FX controls can’t happen overnight,” he adds. “The objective then is to accept a common set of disclosures, a common set of approval processes, and to be able to have one program that is approved by all the jurisdictions. From there, you can tap the respective markets. Once that happens, you can have one company setting up that program and having it blessed by several entities.”

The prize is well worth the challenge. Standardization allows issuers to diversify their fund-raising options, reducing the twin reliance on local funding and US dollars. Investors gain greater opportunity.

“The more integrated the Asean economies become, the better it is for the capital markets,” says Muraki. “A more free flow of capital and people and business should become more interesting for fund-raising and investing.”

BOX: The rating agency question

Lee Kok Kwan at CIMB puts part of the blame for lack of cross-border investment on international rating agencies. “The international rating system has a problem, because the main bottleneck is in the sovereign rating,” he says. “It doesn’t reflect real underlying credit fundamentals and the probability of default.” It’s a bottleneck because sovereign ratings cap corporate and bank ratings.

He cites the example of Thailand, with negligible foreign currency debt, around $169 billion of foreign exchange reserves, and self-sufficiency so strong that the country imposes withholding taxes to discourage hot foreign money from buying it. “The capital account is in good shape, but it’s rated much lower than, say, France, Italy or Spain,” he says. The treatment of banks like Bangkok Bank is similarly imbalanced, he says. “Why is Bangkok Bank, with a much lower leverage of 10 times and funding comprised mostly of customer deposits, rated lower than higher leveraged French, Italian or Spanish banks that are also more exposed to wholesale funding? Are Thai mortgages really that much more risky than French or Spanish or Italian mortgages?”

The lack of international agency ratings of local currency government and corporate bonds causes a problem, because the investment and credit committees of central banks, pension funds, mutual funds and commercial banks in the region tend to require international ratings when investing cross-border.

And, so far, local agencies carry no weight cross-border. “A local rating means everything to a local investor, but internationally local ratings don’t mean very much,” says James Fielder at HSBC. “One local rating doesn’t necessarily help doing deals in another country because they don’t recognize it.”

A challenging but useful goal is a single rating agency for the region. “S common one across Asia would take a lot of coordination and buy-in from different countries,” says Clifford Lee at DBS, so in the meantime “we should go one baby step at a time: one common set of disclosures, one common set of programs. Right now we don’t even have programs: they have to be approved issue by issue. If you have one-time approval for a program and thereafter you require ratings onshore, that’s fine.”

CIMB’s Lee says that, looking at local rating agencies such as Perfindo, TRIS or RAM, “if you look at their credit rating migration tables and default rates, with 15 years of credit history straddling the 97/98 crisis, their numbers stack up well.” Smarter investors have long since ignored the strange international ratings of Asian countries, he says, “otherwise nobody would ever invest in government bonds in rupiah, renminbi, ringgit, baht or Korean won.”

Thomas Meow at CIMB argues that the recent Genting Singapore dollar deal, discussed in more detail in the issuance section, demonstrates how important mutual recognition of ratings is. The Malaysian regulator approved the deal to be sold in Malaysia even though the deal did not carry a rating by a Malaysian rating agency. The result: 24% of it was placed into Malaysia. “That shows how important mutual recognition of ratings and regulation is in facilitating cross-border issuance and investment in Asean + 3 countries,” says Meow. “For us to progress further, we need more countries to put in place mutual recognition in regulations and ratings.”

[END BOX]

Section two: Issuance

“I’m old enough to have existed in a world before the Asian crisis when Malaysian entities were issuing in baht, Indonesians in rupiah, and Thais in Indian rupees,” recalls Clifford Lee at DBS.

How far away are we from getting back to those days? Leaving aside the special case of offshore RMB in Hong Kong (see box), Lee Kok Kwan, deputy CEO at CIMB, says cross-border issuance of local currency bonds is “a bit spotty”. There is selective issuance, notably in Singapore dollars, and among Korean issuers into baht and ringgit. But activity is “quite one-off; there’s no activity that is broad based.” And while local government bond markets in the region can have high levels of foreign ownership, it tends not to be from the region. “In rupiah more than 30% is owned by foreigners, but it’s not much from Asean + 3, instead western funds. In ringgit, too, it’s mostly western funds.”

The handful of international banks that play a true role in the development of local currency bond markets in Asia see progress, but also challenges. James Fielder in debt capital markets at HSBC highlights the offshore RMB and the Singapore dollar markets as being the ones with the most cross-border activity. “I would put those two markets into one tier,” he says. “Then further afield the markets have remained more domestic: an Indonesian issuer issuing in Indonesian rupiah to Indonesian investors.” HSBC has long sought “to develop this interweaving of the markets and recognize that an issuer in Indonesia can sell a bond not only to Indonesian investors but to international investors within Asean or further afield,” and lately he has seen progress in Philippine peso, Thai baht and Indonesian rupiah.

He says one impediment is documentation. “International investors generally want international documentation; they want English law.” And there is just no comparing the norms of developed world bond market execution with that in many Asian markets. “If I bring a deal in Singapore dollars, I launch it in the morning, build it through the day and by early evening close the deal,” he says. “The whole thing is completed in a day. In Indonesia, the whole process can go on for weeks.” That is naturally discomfiting for many investors. “You may find in Indonesia that investors won’t necessarily know for some time if they have been allocated at a particular level or not. Generally investors don’t accept that: they want to know, and if things move, they don’t want to be on the hook.”

For regional fund managers, Asean’s bond markets offer a great amount of opportunity. Ong Guat Cheng, SVP for strategy and currency at state-owned Fullerton Asset Management in Singapore, says Fullerton invests in RMB (both CNY and CNH), Hong Kong dollars, rupiah, ringgit, pesos, Singapore dollars, baht, dong, yen and won. But that doesn’t mean they’re integrated. “They are largely separate,” he says. “Several of these local currency bond markets are traded and settled locally, and subject to onshore trading hours. The cross-currency swap market is not developed in many markets.”

Ong has a wish-list of things he would like to see developed, but they are mainly to do with individual markets: increased market access to onshore CNY, less restrictive currency conversion practices (such as the fact that pesos, rupiah, baht and dong can only be traded through custodian banks), more deliverable forward markets (since several Asian currencies are traded in non-deliverable forwards, making FX hedging less efficient), interest rate futures for duration management, and the reduction of abolition of withholding taxes. A more transparent issuance schedule would also help, he says. For integration, “ideally, standardization of local ratings agencies against the international rating agencies” would help, he says.

Fundamentally, cross-border issuance will always come down to costs. “It depends on relative funding cost and market accessibility to local issuers,” Ong says. “More cross-border issuance would happen if issuers can fund more cheaply in other currencies, swapped into their own base currencies. This typically happens if there is strong investor demand for a strong credit name in another local currency base.”

At Malaysia’s Employee Provident Fund, one of the region’s most influential institutional investors, there is a frustration at the paucity of cross-border issuance. “The main challenge is the lack of private sector participation,” says Wan Kamaruzaman. “Not many corporates are taking the route to raise funding requirements via the capital markets. Cross-border issuance is not even in their mind.” Those that can go cross-border, he says, do not do so because of the difficulty in managing the risk. Still, she sees issues by Khazanah and by Korean institutions as “steps in the right direction”.

Wan is also aware that institutions like hers can be part of the solution. “In our opinion, the role of big institutional investors in each market is crucial here,” he says. “The EPF represents approximately 30% of the Malaysian bond market. We operate on the fact that we need the market and the market needs us. Therefore, a responsible and active institutional investor is critical to the progress and development of every market.” Wan says this because he wants to see the EPF, and its peers, more closely involved in cross-border projects. “Regulators should always rope them [institutional investors] in to their initiatives to develop the market,” she says. “This initiative is currently lacking.”

What difference would more integration make for a house like the EPF? At the moment, quite a lot. The EPF has been given approval to invest up to 23% of its fund in non-ringgit assets. At the end of 2011, the EPF’s total assets were RM469.2 billion and its non-ringgit exposure US$17 billion, or 13.2%; its asset allocation to non-ringgit fixed income is just US$1.75 billion, or 1.18%, against a target of 5%. “Therefore, there is a need to further escalate and diversify our assets into regional and global fixed income assets. Greater harmonization in the region’s local debt markets will indeed help accelerate this diversification requirement.”

So where are we seeing success?

Singapore is one market where it does feel like progress is being made towards cross-border integration in the region. At the time of writing the biggest Singapore dollar debt deal so far this year was a S$1.8 billion issue for Genting – a Malaysian issuer. Morever, around 42% of its distribution took place outside Singapore, and 24% of it into Malaysia. A non-Singaporean Asean issuer, launching in size in Singapore and bringing in investors from across the region, is exactly the future that groups like the ADB would like to visualize for the region’s bond markets.

Genting was an example of the perpetual format which is increasingly common in Singapore, and in fact has been attracting foreign names for years. Last year, it was the Hong Kong property and infrastructure groups like Cheung Kong Holdings and Henderson Land. Recently a Chinese real estate company, Central China Real Estate, took the same route.

Such cross-border interest in Singapore dollars “will continue to grow,” says DBS’s Lee. “We have just scratched the surface. We had a book size of just under S$6 billion from Genting, from 135 accounts, and we can have a lot more interest coming in.”

The Central China deal, a S$175 million raising led by Deutsche Bank, Morgan Stanley and OCBC, was as striking as the Genting one, but in a different way. While the Genting deal showed the liquidity available for blue-chips from the region, Central China showed there was appetite for lower-rated names; it is rated Ba3/BB-. It would have struggled to complete a deal in the international bond markets, particularly following the recent downgrades of fellow developers Glorious Property Holdings and Powerlong Real Estate Holdings, so the appearance of the Singapore dollar bond market as an alternative for Chinese property developers is potentially very influential. With the deal paying 10.75% yield, there’s clearly an appeal to investors too. Meanwhile, blue chips continue to appear; at the time of writing Hutchison Whampoa was expected to issue.

The lesson of the Singapore dollar perpetual experience is that there can be intra-regional cross-border interest provided the trade makes sense for issuers. “There are two main drawing points,” says Lee at DBS. “First, of course, it must be cost-competitive. Secondly, there must be a certain level of execution certainty.” In the case of perpetuals, many successful local deals – recently including GLP, Singapore Post, Mapletree Logistics Trust and Ascendas – have helped to demonstrate to cross-border issuance that certainty of execution. “It must be a reliable source of capital. It can’t be: tap it once and it closes up.”

Another active market for cross-border issuance has been Malaysia, which began liberalization of its local currency bond markets with multilaterals like the IBRD, IFC and ADB, and now attracts a range of names. A recent example of an Asean issuer following in their footsteps was the RM750 million sukuk by TTM sukuk, an SPV set up by Trans Thai-Malaysia (Thailand). Heading outbound, a recent cross-border example was the S$1.5 billion trust certificates from Danga Capital, a Malaysian institution.

Ringgit-denominated corporate bond issuance tripled in the first quarter of 2012 year on year, to RM38.97 billion, and the main prompt for the increase was issuance from Korea and India.  This has been going on for some time. In the last year, Hyundai Capital Services has raised RM650 million of 2.5 year bonds, Woori Bank raised RM315 million of three-year bonds in September, and the National Agricultural Cooperative Federation of South Korea raised RM310 million in three-year funds in October.

Koreans have long been at the vanguard of cross-border issuance within the region, most recently in baht. Three times a year, Thailand’s Ministry of Finance invites foreign entities to apply to issue in baht, and then comes out with a list of approvals specifying how much issuers can raise and when they need to do so by. These are open to all-comers, but in practice what it actually leads to is a long list of Koreans. The latest round of approvals came on January 9 with seven names, five of them Korean: Hana Bank, Industrial Bank of Korea, Korea Development Bank, Export-Import Bank of Korea (Kexim) and Korea National Oil Corp. All but the last of those had all sold bonds in baht the previous year too.

Most recently, Hana Bank raised Bt 10 billion (US$324 million) in a two-part issue in January, Bt8 billion of it in three-year funds at 4.68%, and Bt2 billion in seven-year paper, at 4.49%. Earlier in the month, Woori Bank had raised Bt5 billion in a three-tranche deal: Bt2.5 billion of three-year paper at 4.08%, Bt1.5 billion of four-year at 4.22%, and Bt1 billion seven year at 4.47%.

For the Koreans, the deals have offered savings on an asset-swap basis, bearing in mind the combination of the local currency fixed rate required to get the deals away, and the cross-currency swap rate. “Korean banks are happy to raise money in any currency as long as when they swap back to dollars it is equivalent to what they could raise in that market,” says Fielder. “They are very happy to seek out new deals and new markets if the cost is comparable to raising money in one of their existing markets.”

This observation explains why Koreans are active across a host of Asian currencies – not just baht and ringgit but yen, RMB and Hong Kong dollars, and even occasionally rupiah. “More and more Korean banks are paying attention to the Asian currencies to raise funds,” Seung Won Yang, head of global funding for Korea Development Bank, told our sister publication Asiamoney recently. “This increasing attention comes first from the need to diversify its funding source, and second because the global financial turmoil has made it more difficult to raise funds from the traditional G3 markets.”

“KDB believes that Asia is becoming a more attractive place to issue new bonds,” he said. “The decision to issue bonds comes not only from market conditions, but also from the funding needs and plans of each bank, and we plan to continuously monitor Asian markets to make an issue at the optimal timing.” Fung Hwan Choi, head of funding at Kexim, added: “Thai baht bonds are normally 10-20 basis points tighter than the global dollar market. Because we need to swap these currencies into US dollars after issuing in other currency markets we need to compare the rolling costs on a dollar basis. That’s why we’ve been attracted to emerging markets in Asia.”

And that, more than anything, will be the decider in the next wave of cross-border issuance: because it makes sense financially.

Box: The sovereign view

One of the markets with the highest proportion of foreign ownership is Indonesia. As of January 2011, foreigners accounted for 29.5% of tradable rupiah bonds, and last year the figure was sometimes in the high 30s. Foreigners were net buyers by Rp60 trillion in January. Rahmat Walyanto in the debt management office of the Indonesian finance ministry argues that any decline in foreign ownership does not reflect flagging interest so much as an improving domestic picture. “The portion of local institutional investors such as local banks, insurance companies and the number of retail investors has increased,” he says. “This is a very good sign indicating a widening domestic investor base.” Indeed, if anything, Indonesia is putting more effort into increasing domestic holdings of local debt rather than international, partly because of fears of what happens when the foreigners start to pull out.

It is hard to tell just how much of the foreign investment in Indonesian bonds is from within the region; a great deal goes through Singapore, for example, but that doesn’t just reflect Singaporean money but international money transacted through that hub.

Waluyanto thinks that Asean + 3 bond market integration “would help channel regional resources to regional investments, leading to sustained and balanced regional economic growth.” He says the ministry has discussed with other regional counterparts issues such as bond market infrastructure, settlement cycles and regulatory frameworks. But there is a slight undercurrent of concern here too. “In supporting the initiatives, Indonesia as the country with the biggest market potential always demands a level playing field because we do not want to see other countries taking benefit from our market,” he says.

One area where Indonesia may become more of a regional hub is on the Islamic side. Clearly, today Malaysia is the regional (and world) leader for sukuk as in all areas of Islamic finance, but there is a growing recognition in Indonesia that there is an opportunity in the sheer scale of its Islamic population. Certainly, Malaysia-Indonesia cross-border Islamic sukuk should be a possibility. “We have an ambition to make Indonesia the world sukuk market hub in five years time,” says Waluyanto. For that to happen, it’s going to need a cross-border perspective.

BOX: Regional issuance

Multilaterals and central banks have long sought to prompt cross-border investment in local currency bonds with their own bond programs.

The first Asia Bond Fund was launched by the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP), which includes the central banks of 11 economies and most Asean+3 nations, in 2003. That first US$1 billion fund was set up to invest in a basket of US dollar denominated bonds issued by Asian sovereign and quasi-sovereign issuers. The second, announced in December 2004 and implemented the following year took US$2 billion in funding and was made up of a pan-Asian bond index fund and eight single-market funds, all in Asian local currencies. This was designed to provide easy and efficient ways for regional and international investors to get diversified exposure to Asian bond markets.

Market participants have long called for an ABF 3 with a private sector focus. “We think the next step is to have a catalyst fund to invest in local currency corporate bonds in the Asean + 3 region,” says Thomas Meow at CIMB. “Also it is crucial, if we are talking about Asian excess savings investing back into local markets, to have central bank reserves putting some money into a fund that invests in Asean + 3 local currency corporate bond markets.”

Lately, work at the Asian Bond Market Forum has focused on AMBIP, a standardized bond issuance program to facilitate cross-border or intra-regional issuance of and investment in bonds. The idea of AMBIP is to make it possible to issue in participating economies with standardized, one-time documentation and disclosure procedures, and allows qualified investors to sell and buy across borders regardless of their location. Unlike the Asian Currency Note Program and Pro-Bonds, this should be the first initiative with the regional perspective of Asean +3. The target is to introduce AMBIP by the end of 2013, by which time pilot bond issuance should have taken place.

BOX: The special case of China, onshore and off

One market that represents huge opportunity for cross-border issuance from Asean nations is the CNH, or dim sum market. Citic expects CNH debt new issuance to be between RMB250 to 300 billion in 2012.

A look at recent issues demonstrates a number of cross-border issues from the region, particularly Japan, from where Hitachi Capital, Mitsubishi UFJ Lease, Mitsui & Co have all launched issues in 2012, alongside Lotte Shopping of Korea. (Naturally, a large number of Chinese and Hong Kong borrowers have used these markets, which could arguably be considered cross-border in that CNH is offshore.) From southeast Asia, examples include Khazanah issuing CNY500 million  in trust certificates, and Genting Hong Kong issuing CNY1.38 billion in unsecured bonds.

It helps that the market is maturing and no longer represents the cowboy country it did in its early months, when almost anyone seemed to be able issue to raise tightly-priced funding even without a rating. As fund managers have entered the market, discipline has appeared, and there is now a more sensible balance at play between supply and demand. Pivotal to this has been a levelling off of RMB deposits in Hong Kong, which at one stage were rising stratospherically, creating demand for CNH that removed all reason from the market; as of February 2012, deposits stood at RMB566.2 billion, which is high but no longer wildly out of step with supply. In 2011, for example, there were 141 RMB bond issues with a combined worth of RMB124.4 billion, while Chinese domestic banks received regulatory approval to issue over RMB25 billion in offshore RMB during the first half of 2012.

Also vital to a maturing of this market has been a change in currency expectations. “The RMB used to be a one-way bet for appreciation,” says a corporate finance banker at CITIC Securities. “But from the second half of last year to the first half of this year, that expectation has diminished. From my point of view, I think this is not a bad thing: the one-way bet expectation was harmful to the market development and bad for RMB products like bonds.”

The RMB is steadily moving further offshore, as the landmark issue by HSBC in international RMB out of London demonstrated in March. And as it moves, it’s likely that more and more Asian issuers will take advantage. “Last year and year to date, the majority of issues in offshore RMB were from companies incorporated in Hong Kong or outside China,” says Citic.

Increasingly, as swap markets improve, this allows issuers to swap back the proceeds to their local currency. Alternatively, it gives Asean issuers an opportunity to invest into China using the RMB proceeds, creating a natural hedge on currency exposures. It hasn’t always been straightforward to remit RMB elsewhere, but a new circular issued by the Ministry of Commerce in October clarified some of the approval application procedures for the remittance of offshore RMB FDI into the mainland.

Domestically, markets see little international participation, but it is still worth keeping an eye what is happening on the mainland because of the sheer scale of issuance.

The Chinese domestic corporate bond market involves three main products: one for corporate bonds of listed companies, covered by the CSRC; one regulated by the NDRC, covering bonds of non-listed companies; and a third, called NAFMII (National Association of Financial Market Institutional Investors), which hosts MTN, CP and SME Collective Notes products for non-financial companies. Additionally, there are bonds for financial institutions, covered by the CBRC and PBOC.

It’s in the NAFMII and CSRC area that market participants see real progress. In particular, there has been growth in private placement MTNs, which previously focused on AAA-rated central state owned enterprises; now the range of issuers who can launch these programs has been expanded, and NAFMII is considering new regulations to build up the number of qualified investors who can participate in these private placements. At CSRC, another new product is being developed on a pilot basis: asset-backed securitization for non-financial companies

“The Chinese domestic bond market does not have a long history,” says the Citic banker. “But we think it has great potential to develop in the future, and it has seen great progress already.”

Chinese bond markets are largely domestic in terms of investor participation, but foreign investors can participate in the debt via Chinese incorporated foreign entities like HSBC in China. And another area of progress in international engagement with the mainland is the RQFII program, which allows RMB held offshore to be reused by qualified foreign institutional investors in the domestic markets. 80% of the RMB20 billion of capital approved so far for this program is expected to go into bond markets. “The RMB is our sovereign currency, and the bond market is one of the ways it will be internationalized,” says Citic.

BOX: Pro-bond

One transaction watched closely by harmonization aficionados was the first Pro-bond transaction, a new format for issuance in yen. ING launched the market with a Y50.7 billion issue in April.

This has implications for regional integration. “One of the things we are trying to do is compare the issuing documents, and identify the areas of difference between ING’s MTN euro program and its Tokyo pro bond issuing prospectus,” says Maruki at Tokyo-AIM. “Although the gist of the materials is the same, there are certain differences, and that will become the basic format of a listing document. When we harmonise the markets, we are hoping similar things will happen in other parts of Asia. Hopefully it will all filter through the system and we will all be under a similar regulatory environment for issuing.”

“If you think about the market from the issuer perspective, they look for liquidity and market depth,” adds Maruki. “That will drive the spread and give an opportunity for future funding.” On that reading, ING was a good name to open the market, as it demonstrated that a European A+ borrower was able to attract good demand from Japanese institutional investors – the banks, the life insurance companies, and the regional banks. “What’s more interesting is that ING was able to attract Asian demand for yen product. And that’s a very interesting development, because when people think of issuing yen in Japan, they think of it as Japan investor focused.” So what brought Asian investors in to this paper when, in a samurai format, one would only have expected Japanese participation? “They liked the name, they liked the rating, but most of all they liked that the documentation was in English,” he says. “If it’s a samurai, the documentation is in Japanese, which makes it harder for them to buy. The language part has proven to be very important for the investor and issuer in Japan.”

On top of that, strong international ratings are helpful, and the infrastructure for clearing and settlement is important. “These are the lessons we are gathering, and we want to disperse that knowledge into other parts of Asia. If a company in Malaysia or Indonesia or Thailand can come to Tokyo and issue a pro-bond, not only to Japanese investors but to Asian investors coming and buying this paper, that widens the opportunity for Asian issuers accessing a broader investor base.”

However, not everyone is as enthused. “Pro-bond only accepts international and Japanese ratings, and Japanese law,” says Thomas Meow at CIMB. “That will create problems for many Asean+3 corporates in tapping the Japanese bond markets.”