A decade in Asia’s debt markets

Credit magazine, Feb 2010

When Credit magazine started out 10 years ago, Asia was still fighting its way back from the financial crisis that had rocked the region through 1997 and 1998. A decade later, its reaction to another crisis –this time global – would illustrate just how much Asia’s debt markets had grown in maturity in the meantime.

A first glance at the volume numbers might suggest that the big story of the last 10 years has been the development of the G3 markets for Asian issuers. Volumes have more than trebled during that period, from US$19.2 billion in 2000 to US$65.7 billion in 2009, according to Dealogic. But really, that’s a story of the first half of the decade: most of the increase had come by 2005, when volumes topped $50 billion, and declined thereafter until the huge refinancing needs that came through last year. “Most of the growth happened in the first five years, since when we’ve been running at a pretty steady pace,” says Fergus Edwards, head of syndicate at UBS, based in Hong Kong. He also downplays the significance of that growth, pointing out that compared to the US$1 trillion dollar market for US borrowers, it’s “barely out of the blocks: there’s so much capacity for market growth.”

Instead, the more significant shifts during that period are about international investor attitudes to Asia, the wider range of credits and in particular the growth of local currency bond markets – most recently China’s.

In the last 10 years, the role of Asian debt in the global portfolio has been transformed. “The pool of people who buy emerging markets is significantly deeper,” says Sean Henderson, head of debt syndicate, Asia Pacific, at HSBC. “Back in 2000 the market was more niche in the fund management community: there was a specialist investor base who covered Asia with relatively small amounts of capital, or else it was a small part of the global portfolios used just for yield enhancement.” That has changed. “Now, the view is that Asia is a significant driver of the global economy and you absolutely must have exposure as part of your long term strategy.

“These days when you’re doing a high quality offshore deal from Asia it’s very rare that you don’t get all the major global fund managers taking down a good portion of it,” says Henderson; the week before the interview, HSBC had been a bookrunner on a US$1.5 billion bond for the Republic of the Philippines that raised a US$10 billion book. “In fact, the most common complaint is wanting to see larger, more liquid benchmarks.”

Here again, though, Edwards believes much more can be achieved. “You could make the argument that the problems of the past year would have been mitigated if international investors had bought more Asian debt,” he says. “Investors were all holding the same risks, especially in US housing markets, just cut and recut and pretending that each transaction was a unique and uncorrelated risk. If investors had bought more Asian debt within the same investment portfolios then they would have seen proper diversification across differentiated assets.”

Another major shift in the Asian debt markets in the last 10 years has been the range of issuers who can access the capital markets. At the heart of this is the development of high yield. In truth, a high yield market has existed in Asia for some time – some sub-investment grade Indonesian issuers were accessing dollars as far back as 1993 – and one could argue that some deals done before the Asian financial crisis could still not be repeated today. But it is only in recent years that the high yield market has started to regain momentum and to broaden, in terms of range of issuers, availability of volume and range of tenor. “Investors had a very long memory about some of the defaults during the Asian financial crisis, and it did take a while for the market to come back,” says Sykes. “But it has come back, and we are doing things we would not have been able to do back then. We would never have seen Chinese real estate deals back then, or the size we’ve seen from single assets or single companies.”

Paul Au at Citigroup Global Markets considers high yield one of the key developments of the last 10 years. “We see more corporate issuance from more diversified sectors across the region,” he says. “You see Singaporean, Indonesian, Hong Kong, Korean issues tapping high yield. You see coal, property, a lot more types of issuers. That trend is going to continue to grow.”

Additionally, although high yield did exist in 2000, one could argue that the gap between it and the top issuers has since been filled in. “It feels like there was a bifurcated market back then,” says Henderson. “There were the investors who bought only top quality Asia, such as the sovereigns and the very big blue chip companies like Hutchison Whampoa; and then you had real high yield specialists. Today we are more likely to see the full range of credits coming to the market from AAA through to B ratings, and investor demand exists for almost any deal across that range. It is much easier now for the mid-tier corporate to issue than it was back then.”

But probably the most important change to have taken place in the last decade in Asia is the emergence of domestic bond markets – and this is where the bookending of the decade with two financial crises provides such telling evidence of change. The Asian financial crisis was, if not caused, then certainly exacerbated by the lack of local currency funding options for Asian companies and banks. Many had sought to raise capital through the dollar markets, but then found themselves in trouble when their currencies declined dramatically against the dollar in 1997 and 1998. Indonesian corporates, for example, found that the cost of repaying that debt multiplied eight times over in a matter of weeks. That currency mismatch was at the heart of the crisis, and if local companies had had the option of raising their funds in their own currency, the problems would have been nothing like as acute.

This time, when the global financial crisis shut down the G3 markets, many Asian companies that needed funding were able to simply go local – to Malaysian ringgit, Korean won, Thai baht. Data from Dealogic shows that total raised in Asian local currencies, ex-Japan, hit a record US$397.55 billion in 2009, an almost eightfold increase from the US$50.6 billion figure in 2000. Six times more was raised in Asian local currencies than by Asian issuers in G3 currencies in 2009.

Consider, for example, the week that Lehman Brothers defaulted and Merrill Lynch was taken over by Bank of America. That same week, Maybank raised M$1.1 billion of tier one debt in Malaysia’s domestic markets, through Deutsche, Aseambankers and HSBC. A bank borrower being able to raise tier one funds in the same week Wall Street seemed to be collapsing says everything about the newfound resilience of Asian domestic debt.

Partly, this is a function of an emerging Asian investor base that really wasn’t there a decade ago. No Asian country has a pension fund market on the scale of Australia’s superannuation industry, but gradually they are getting there: Malaysia’s Employees Provident Fund, Hong Kong’s Mandatory Provident Fund, Singapore’s Central Provident Fund, China’s National Social Security Fund. Alongside the pension funds are emerging insurers, and developing mutual fund industries. In combination they are creating a strong domestic bid for local paper, and one that doesn’t really care what is happening to American banks from one day to the next. “Ten years back, the investor base for Asian paper was predominantly out of the US, with investors there taking leadership in shaping transactions,” says Au. “It was the driving force of Asian paper. But with the growth of the regional economy, the wealth created, and with a better understanding of fixed income product, we have seen increased appetite for Asian credits from Asian investors.”

“Asian investors now define most of the trades we do,” he says.

The result is a powerful, and new, local currency bloc. “Asia’s individual domestic capital markets in many cases exist in a way that they absolutely did not 10 years ago,” says Rod Sykes, head of debt capital markets, Asia Pacific at HSBC.

For him, the deal that underlines this transformation is another that took place during the global financial crisis – the P38.8 billion (US$800 million) raising for San Miguel Brewery in Philippine pesos in March 2009. This was by any measure a staggering achievement: San Miguel Brewery, having been spun off from San Miguel Corp, was a first time issuer in any debt market, and was approaching investors in the middle of the worst global financial crisis in memory. Yet it quadrupled the previous record for a Philippine peso bond issue. In ordinary circumstances SMB would probably have gone overseas for its money, but in early 2009 couldn’t do so; consequently it learned that there had been no need to try as all that they wanted could be found at home. The local currency peso market barely even existed in 2000; the almost P150 billion raised there in 2009, while only a quarter of what was raised in Malaysia that year, represents an exponential increase and even a near doubling from 2008.

But how much scope for further growth is there? Markets like Malaysia have arguably already got towards the natural limits of domestic fundraising requirements; the imperative now is to attract foreign issuers into that market, which is limited by the slender swap market to take proceeds back out of ringgit again. The same problem applies in other markets, creating an apparent ceiling to development.

“There’s a certain pool of assets held within Korea, and a certain pool of borrowers who would like to raise won for their liability profile – and that’s clearly capped,” says Edwards. More broadly, he points to the lack of a common and universally understood legal system across Asia as an inhibitor of further cross-border development – and the lack of a common currency, “and that development isn’t exactly imminent.” More pragmatically, Asian bond markets would probably have grown more if it were not for the fact that the loan market in many Asian nations is so strong. Asian banks by and large remain highly liquid and reduce the need for capital market funding.

There is, though, an exception – and this will be the most exciting story in Asian capital markets over the next 10 years. This is the Chinese renminbi market. There were no deals whatsoever in this market in 2000; one, worth $604 million, came in 2001, according to Dealogic. In 2009, that total hit US$222 billion from 428 issues: more than half the volume of all Asian local currency markets that year. “The growth in that market is just phenomenal,” says Henderson. And perhaps the most striking thing is that this market has only just begun. “Back in 2000 it barely existed, and it’s difficult to argue that you’re going to see growth at that kind of pace. But there has to be some element of growth just by virtue of the underlying economy.”

Edwards says there is “huge potential for that space to grow”. Partly, that’s because of continued demand by Chinese issuers for capital, “but also because of the amount of companies from outside of China who wish to enter that market and fund growth in their Chinese operations,” he says. “Somebody like a Wal-Mart wants to grow their Chinese domestic business, and who comes from a market extremely familiar with using local bonds to fund local growth.”

Using the funds for local growth removes any need for swap markets, which limit the growth of other local currency markets; all that’s stopping it from happening is the regulatory environment, with only the IFC and Asian Development Bank permitted to issue in RMB so far. That said, several banks have issued in RMB in Hong Kong, another highly significant development, and one covered in the most recent edition of Credit.

If China does open up its domestic bond markets to foreign issuers or investors, it will be the most significant step of the next decade.

And even if the scale of new issuance doesn’t continue at the same exponential pace, the market will grow in sophistication. “I expect most of the development will be in the broadening of the investor base, the developing of more complex products, and in the syndication strategies,” says Henderson. “Rather than a relatively few key investors, you will start to see a more developed insurance, pensions and fund management community and an increase in the range of products to suit their needs. That’s going to be the major story of the next five years.”

 BOX: The deals of the decade

Asked for their views on the key deals of the decade, most people point to recent deals: those that demonstrated Asian resilience to a global financial crisis, thus proving how far things have moved in the last 10 years. For Sykes, that’s the San Miguel deal; for Henderson, the tier one deals for Maybank and UOB in local currency mid-crisis. For Edwards, it’s “the point at the start of last year when the world was really in trouble, and emerging market sovereigns were trading in double digits – but Indonesia still managed to raise $3 billion of financing. That’s the point at which we saw that Asia had moved well beyond the issues of 97.” He also highlights the first bond deals for the Chinese sovereign and the long dated funding raised through 30-years deals from issuers such as Thai energy company PTT in 2005. Au points to the $5 billion raising for Hutchison Whampoa in 2003, a “market defining trade in terms of its scale.”