Credit: the changing face of the Asian bid

Credit Magazine – November 2010

The Asian bid has evolved in the last 10 years, changing the nature of the marketing of global debt securities. Where once the idea of Asian demand just meant the central banks, today it involves a wall of high net worth wealth, and in future will include a sophisticated fund and insurance pool.

“If you look back at the early 2000s, when we referred to the Asian bid it was always in reference to central bank liquidity,” says Paul Au at UBS in Hong Kong. “Since then we have seen a slowly evolving trend towards a more diverse investor base in Asia.”

The largest and most renowned block of wealth in Asia remains the central banks, which include some of the largest institutions in the world, notably the foreign exchange assets entrusted to the State Administration of Foreign Exchange by the People’s Bank of China. But this has always been a limited group in terms of the type of securities it will buy. “Central banks have historically been very big buyers of senior financials,” says Simon Derrick, head of ex-Japan Asia institutional sales at JP Morgan. “They stopped during the financial crisis but there has been a re-emergence of risk appetite in the last 12 months, although not nearly as widespread as before. They have continued to heavily focus on supranational and sovereign paper.”

The emergence of an Asian bid for other kinds of paper is more recent, and has been driven in particular by the appearance of private wealth as an investor pool for debt securities. “One area where I think the Asian bid is very different to the US is that the volume of Asian private banking assets is immense,” says Mark Follett, head of high grade capital issuance at JP Morgan. “That concentration of high net worth wealth lends itself at times to incredibly attractive issuance opportunities for retail-driven transactions – those with a slightly higher coupon, because the instrument might be perpetual in nature, or some other feature that allows you to get very attractive funding done.”

Follett is not alone in highlighting this part of the market. “The private banks have always been quite active in our markets but particularly from 2004 to 2007, and have re-emerged as large investors this year,” adds Devesh Ashra, head of Asian debt syndicate at Credit Suisse. “As the financial crisis came about they became more cautious in the types of securities they would buy, but with renewed stability we have seen them focus on yield products like perpetuals.”

This part of the Asian bid has supported a whole new sub-plot of world capital markets: issuers from worldwide, and in particular Latin America, bringing deals partly with that Asian wealth bid in mind. “Many are from Brazil, which has a similar economic backdrop to here in the region: a high interest rate environment and good growth prospects,” says Ashra. “It also helps that one of the largest trading partners of Brazil is China, so it’s definitely a regional trade story.”

Issuers of such paper this year have included Pemex, the Mexican petroleum major; Braskem, a Brazilian corporation; Odebrecht, a Brazilian conglomerate; and CSN, an iron and steel company headquartered in Rio de Janeiro. And it’s not just the Latin Americans. A number of other issuers have launched perpetual paper chasing Asian retail demand, including Cheung Kong Infrastructure and commodities groups such as Switzerland’s Glencore and Australia’s Santos. Earlier in the year, a preferred perpetual from HSBC, offering 8% and callable in five years, was pitched firmly at the Asian retail bid, followed by a similar issue from Credit Suisse paying 7.875%. “Provided yields stay attractive and they continue to perform in the secondary market – which most have – we would expect the bid to continue going forward,” says Ashra.

Although it depends very much on the type of deal, the involvement of Asian investors in global deals like this can be considerable. “If you were looking at a bank capital or hybrid capital issue from a name like Credit Suisse or HSBC, Asian investors obviously know those names and provide strong support for those transactions,” says Au. “50% Asian distribution would not surprise me.”

But while the bid has supported a certain kind of transaction, it doesn’t have the steadiness of more traditional institutional blocs. “We’ve seen issuers repeatedly, and particularly since the crisis, execute at very attractive terms to attract the Asian private banking bid,” says Follett. “It’s very effective. But it’s not a real money investor base that needs to constantly invest: if the market’s not good they can buy commodities, equities, property – anything.”

What’s lacking is what European or US investor bases tend to think of as real money. “When I contrast the investor base in Asia to that in the US market, we have fewer of what I would call real money accounts here in Asia: asset managers, insurance companies, who are enormous investors in the US,” says a banker. “In Asia you have what I would characterise as a trading investor base, populated by private banking money, hedge funds and banks. The volume of large insurance and pension fund-type money is not large for general corporate DCM issuance.” That’s not the case for very high grade issuers, who can tap into the enormous Asian central bank liquidity, but that money doesn’t reach down to corporate issuers.

On the fund side, there are good arguments for rapid growth in order to start to catch up with those European and US investor bases. “There is a long and potentially sluggish recovery underway in the US and Europe while there is still a very positive outlook for the market here in Asia,” says Ashra. “That underlying premise should mean a lot of fund flows getting channelled into asset managers in Asia. You can already see several global asset managers all beefing up in the region.” Some who have done so include Principal, Schroders, and Pimco. For his part, Au thinks “you will probably see set-ups of real money funds in Asia – insurance companies, long-only bond funds – and could see them in non-Asian transactions. The investor universe is going to grow and become more mature in the next few years.”

That maturity, though, is partly going to be dependent on regulation and policy. Asia has large and growing pension funds, as more markets have begun to mandate compulsory savings, but many of them tend to invest domestically. Take Korea’s National Pension Service: it’s a powerful institution, with W289.5 trillion (US$245.8 billion) under management when last disclosed in March 2010, and is growing fast, underpinned by the fact that all Korean workers are covered by the fund. But at the end of 2008, when its asset allocation was last disclosed, 77.7% of the fund was in domestic fixed income, and only 4% overseas fixed income.

However, the NPS is also illustrative because it is paying more attention to overseas markets. It has a long-term asset allocation it hopes to hit by 2014, by which time 10% will be in overseas fixed income. Similarly, China’s National Social Security Fund is chiefly a domestic institution today, but its governing law allows it to invest in a wide range of international debt securities and it has appointed a number of international fixed income managers to mandates, suggested greater allocation to overseas in future. And Malaysia’s Employee Provident Fund, which by June 30 had just US$5.92 billion of its US$130 billion invested overseas, has a strategic asset allocation document calling for 9% of its overall portfolio to be invested overseas – a modest amount today, but EPF’s future is bolstered by mandatory contributions of 20% of all employee wages. Elsewhere, Taiwan’s Public Service Pension Fund perhaps illustrates the future for Asian pension funds: 45.1% of its assets are committed overseas already.

Then there’s insurance, where many countries – China is an example – are broadening the range of securities their insurers are permitted to invest in. None of this will be particularly rapid. “Regulation takes time,” says Au. “There are certain countries that have higher levels of regulatory restriction, such as China; there’s a lot of money there waiting to be released.” But it’s underway.

Still, in the absence of that maturity in real money investors, the Asian bid has tended to boast some unusual characteristics, both in terms of the bid itself, and the way it is treated by banks. Many bankers report exceptionally large order books from Asia, often somewhat insensitive to price, committing to buy at whatever the final price ends up being. Partly this is perhaps a consequence of being the first place physically that a book goes through before heading to Europe and the US. “Many of the deals we’ve worked on have had impressive order books from investors in the region,” says Duncan Phillips on Citi’s Hong Kong debt syndicate team. “As the first group to register their interest in a globally marketed deal it is imperative they feel fully engaged and the transaction gets off to a good start.”

Bankers also report a relatively high contribution of leveraged players in the Asian bid on a global transaction. “These guys tend to be treated rather well in Asia compared to what you may see in the US or Europe,” one banker says. “You find they provide a lot of direction around where they think fair value is on a deal, they are often some of the earliest into the order books, and frequently their orders are the largest in Asia. Compare that to the US where Pimco is your big investor and you expect them to come in with the largest order.” In Asia, what he calls “good quality real money investors” might put in orders from $10 to $50 million, whereas the leveraged players might be from $20 to $200 million in the same deal.

That said, the growth of the Asian bid does need to be seen in some context. “You do find in Asia a tendency to inflate orders,” says one banker. “Their real demand for a transaction may be $20 million, but they could conceivably put in an order for 50 to 100 million. That is something that acts as a mitigant to these phenomenal order books out of Asia.”

This is not something that comes through in official accounts of deals, since banks tend to release details of end allocation, not the order book. However, behind the scenes, there is a difference between the two.

One reason Asian investors tend to do this is because there is a track record of them being crowded out of deals through little fault of their own. “They are the first group of investors that are required to register their interest in these deals, which is by nature of the fact that Asia opens first, followed by Europe and then the US,” says a banker. “As the deal moves around the world and approaches pricing in New York, you can find sometimes that Asian accounts can be overlooked, particularly in deals for US issuers.” In recognition of this, Asian investors will often bid for several times more than they need in expectation of being heavily scaled down.

One deal illustrates why Asian investors can be right to be nervous. In July, State Bank of India raised US$1 billion in a five-year bond, the bank’s debut in the 144a market. A successful deal, paying a 4.5% coupon, it attracted US$4.5 billion of orders. Press accounts of the deal, sourced from bookrunners, say US accounts took 55% of the deal, Asia 28% and Europe 17%. But it is understood that although Asia only accounted for a shade over a quarter of the allocation, it was responsible for more than half of the order book. Apparently at the last moment Pimco came in with a large order on a “fill or kill” basis. “Basically,” says one banker, “in our world you do not turn away Pimco. You do everything you can to give them bonds.” And so Asian investors were pushed out to accommodate.

This is commonplace: a recent dual tranche offering from Woolworths from Australia attracted considerable Asian demand, but gained only 10 and 12% allocations on the five and year tranches respectively, with Asia heavily cut back. There is a self-perpetuating cycle of Asian bids being inflated because of being cut back, but then being cut back further because people know the bids are inflated. “So the Asia order book becomes inflated, and as you go through the allocation process you are cogniscent of that,” says one banker. “The order comes in for $80 million, which means they probably want $20 million, of which they get $10 million.”

But while that may seem unfair, bookrunners are making a conscious choice about what sort of investors they want in a deal, and they are always like to favour long-only, “real” money accounts – a constituency with a far greater standing in Europe and the US than in Asia. Asian accounts, by contrast, can be somewhat dismissively discussed.

“It’s not an investor base you can really rely upon,” says one banker focusing on US issuers. “It tends to float with which way the wind is blowing: when transactions are hot the momentum is good and they can astound you with very large order sizes. But when momentum is bad they can just disappear.” This banker points to the fact that, coming out of the financial crisis, many Asian issuers opted for 144A transactions because of the real money demand that had remained consistent in the US. “Every single Asian issuer who wanted to raise money had to have a 144A transaction because there was insufficient real money demand in Asia to be able to raise funds.”

Unfair? Perhaps. But Asian issuers are likely to be treated in the same way until that real money base develops on the ground. The bright side is it’s only a question of time.