Emerging Markets: Pro-Bonds Finding their Feet

Emerging Markets, IMF editions, October 2015

For years, it looked like the Tokyo Pro-Bond market was going to be the exclusive home of ING. The first issuer on the fledgling Japanese bond market – and the second, and the third – it had the market to itself from its April 2012 debut for two years and a week. But since then, things have changed, and while Pro-bond is not yet a competitor to the samurai market in terms of scale or liquidity, it has sown the seeds to become a diversified and interesting new market.

Today, there are 15 outstanding listed pro-bond issues (with a 16^th, ING’s first, having matured and been delisted) from seven issuers on five continents. You wouldn’t call it a success story yet. But clear progress has been made in the last 18 months, and there is increasing reason for optimism.

“You couldn’t say Pro-bond isn’t a legitimate format: it is,” says Sam Amalou, managing director and head of debt capital markets at SMBC Nikko in London. “Even some established issuers in samurai are looking at Pro-bond to issue a different product within their range. It has developed very significantly over the last few years.”

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The Pro-bond market appeared as a consequence of a change made to the Financial Instruments and Exchange Act in 2008. This change incorporated a new professional markets system, and Pro-bond was the result:  a new debt capital market for professional investors.

From the outset, the pitch of Pro-bond was relative simplicity. “The Tokyo Pro-Bond Market allows for flexible and timely issuances of bonds reflecting the market environment by streamlining procedures to greatly simplify disclosure documents necessary at the time of issuance without compromising the quality of information for investors,” says Japan Exchange Group, which runs the Tokyo Stock Exchange, among other institutions. “Investors are able to easily access all necessary information through the website of the Exchange.”

This is quite a differentiator. There is a lot to recommend about the samurai market: this year, for example, it showed its worth to European issuers when it remained open to sizable new bonds from European banks straight through the Greece crisis, when European and probably American markets were closed to them. It offers true investor diversification and an extremely loyal investor base.

But it also requires a vast amount of work in order to get started. The shelf programme through which most foreign issuers access the samurai markets can take months to get ready, with extremely onerous documentary requirements, and the need to provide disclosure materials in Japanese.

Pro-bond, on the other hand, is much faster. Disclosure can be in English or Japanese, and accounting standards can be Japanese, US or several other international forms. Issuers can list a bond programme, like an MTN, so that they register their financial data and the planned amount of bond issuance for a given year on the Pro-bond market, and then can issue bonds up to the limit of that planned amount whenever they need to do so. There is a wider issuance window than in samurai. And, even for Japanese issuers, the disclosure requirements are more concise than the regular domestic market.

Documents are submitted to the exchange. “There is no need to submit any documents to the Kanto financial bureau or the Financial Services Agency,” says JPX. Bonds must obtain a rating, but that can be any agency that is recognized internationally and by Japanese investors.

It’s a model that particularly suits the first-time issuer in Japan that hasn’t already gone through the process of a samurai shelf. “For issuers who have already tapped the samurai market, they need to continue to do translation into Japanese, so they have no benefit in using the pro-bond market,” says Reiko Hayashi, head of Japan capital markets at Bank of America Merrill Lynch. “But for new issuers who have never tapped the samurai market before, there are good reasons to use Tokyo Pro-bond, because they can save money on translation.

“In order to translate into Japanese for a new issue, it normally takes three or four weeks longer, and the use of legal counsel and a translator.

“If an issuer has an MTN programme already existing, they can choose the Pro-bond market and come to the market quite quickly.”

If there’s a limitation, it’s in the investor base. Pro-bond is only open to specific domestic investors – qualified institutional investors such as financial institutions, listed companies, private companies with over Y500 million of capital, the Japanese government, Bank of Japan and local governments – and non-residents of Japan, plus a few other approved specified investors if they get the necessary approvals. It is not as broad a group as the samurai investor base and, as we’ll discuss in detail below, the securities do not yet appear in key indices, which counts them out of some Japanese investors’ universes.

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The first Pro-bond issue came from ING Bank on April 17, 2012. The Y50.7 billion two-year senior unsecured deal was priced by bookrunners Barclays, Nomura and SMBC Nikko, issued at par and carried a 1.4% coupon. It attracted about 40 investors.

At the time, it was hoped that the deal would attract other new issuers too. But no new deal would follow until December that year, and when it did, it was once again from ING, with two issues launched on December 20.

This was a far bigger deal: a Y164.5 billion fixed rate tranche, which priced at 70 basis points over yen-swaps, and a $11.4 billion FRN, which priced at 80 basis points over three month yen Libor. At that time, the pricing represented about 10bp wide of where ING would have priced in euros, and 10bp tighter than in dollars. This time, lead managers were Barclays, Mizuho and Nomura.

By the time of the second ING launch, pro-bond programmes had been set up by Nomura and South Korea’s SK Telecom, but still, it would be almost 18 months before anybody followed ING. The bank’s vice president of long term funding, Dennis Haring in Amsterdam, often seemed a lone voice talking up the market’s potential, yet not one deal appeared on the market through 2013.

Then, in April 2014, things started to change.

First, on April 25, Banco Santander-Chile launched a three-tranche deal through Daiwa Securtiies, JP Morgan Securities and Mizuho to re-open the market.  It was small – Y27.3 billion across three tranches, a three-year FRN and three- and five-year fixed rate – but at least it was something. And then, Malayan Banking (Maybank) followed on May 23, and First Gulf Bank on July 3. At a stroke, Pro-bond had gone global, with issuance from Europe, the Middle East, Asia and Latin America.

Maybank was perhaps the perfect example of the sort of issuer Pro-bond might attract. An increasingly ambitious Malaysian name with growing regional ambitions, it wanted to set about widening its funding mix, but was relatively new to international markets.

“Japan was the first stop for us in expanding our investor base,” says Odie Lee Yih Hwan, group corporate treasurer at Maybank. “As the most developed bond market in Asia, it made perfect sense for Maybank to develop a following there.”

But could a first-time issuer like Maybank stomach the onerous disclosure and documentation requirements of a samurai? This is where Pro-bond presented a credible alternative. “What attracted us in particular was the short time it took to launch the deal,” says Lee. “The documentation was easy for us. We were pleasantly surprised with the relatively easy documentation requirements.”

So pleasantly surprised, in fact, that Maybank issued twice, first with a Y31.1 billion three-year issue in May through Credit Agricole and Maybank Kim Eng Securities, and then Y20 billion in five-year funds in August.

For a new issuer like Maybank, the relatively small investor base was not a major problem. “While the investor base is relatively smaller, there is keen interest from investors in exploring the Pro-bond format,” says Lee.

But, tellingly, Maybank then went on to launch a samurai issue. “We felt that with two issuance in Pro-bond for Maybank, it was time to look into the samurai market as it offers a more diversified pool of investors,” says Lee. And did it provide that more diversified pool? “Yes it did. The investor pool is vastly different from the Pro-bond.”

It may be that this becomes an established pattern: issuers starting out with a Pro-bond to get the feel of the market, then graduating to a samurai. “Graduation is too emotive a word,” says Vince Purton, managing director and head of debt capital markets at Daiwa Capital Markets Europe. But, speaking generally and not about Maybank specifically, he says: “If you are new to the yen market and are looking at a samurai, it’s a lot of work and time to get the documentation in place: almost a leap of faith. You do all that, and then find out how much demand there is. There is a case for saying: start with a Pro-bond, with simple English language disclosure, and once you have traction with the investor base, it may be time to discuss whether there are incremental advantages in moving to the larger investor base in the samurai market.”

In any event, 2015 brought further landmarks, starting with Macquarie Bank becoming the first Australian Pro-bond issuer in March, with a Y34.1 billion two-tranche transaction in three and five years through Citigroup and SMBC Nikko. The rationale would have been similar to that of Maybank. The big four Australian banks are already stalwarts in the samurai market, and therefore unlikely candidates to issue in Pro-bond, but for opportunistic Macquarie, the smaller market made sense.

“More Australian borrowers are looking to diversify their funding sources by issuing bonds in Japan,” says George Skiadopoulos, head of debt capital markets for Daiwa Capital Markets Australia. “For borrowers with smaller funding tasks the Tokyo Pro-bond market allows access to key institutional investors in a more efficient manner.” Macquarie fit the bill perfectly. “The success of this transaction, as the first Pro-bond issued by a borrower from this region, received the attention of other similarly rated borrowers in Australia. More local companies will turn to Japan’s debt markets in the next twelve months.”

This year has also seen the first major domestic Eurobond deal – a US$1 billion issue from the Metropolis of Tokyo on May 20 – as well as the first CNH deal, a CNY250 million two-year bond from Mizuho. In a statement, Mizuho explained its rationale. “We believe that the importance of renminbi in global financial markets is continuing to increase,” it said. “Mizuho will invigorate transactions denominated in the currency in the Japanese market and expand the future flow of trade and investment between China and Japan.” More than half of the deal was bought by one investor, Dai-Ichi Life Insurance, attracted by the currency diversification, high yield, and the opportunity to support the expansion of Tokyo as an offshore renminbi bond market.

This year has, after an absence, also seen the return of ING.

Today, Dennis Haring can talk about the development of the market without seeming so much of an isolated cheerleader. “It takes time for a market to develop, just as we have seen with the 144a market,” he says. “If you look back, we did our first deal in 2012, and since then there have been some 12 issuers in total who have applied for registration, and we have seen 20-odd deals. So it progresses slowly but surely. I’m very happy with that development.”

ING’s June 2015 deal – a three-tranche issue worth Y81.1 billion in three, four and five-year bonds, through Barclays Securities Japan, Mitsubishi UFJ Morgan Stanley Securities and Mizuho Securities – demonstrated the diversification advantages that the Japanese capital markets can provide. “We had the books open in the week that the news on the Greek referendum hit the screens,” says Haring. “It was a bumpy road, but in the end the investors were loyal to their orders, which in my view is proof of true diversification.”

Haring notes that the advantages of Pro-bond over samurai don’t stop with the initial documentation. “There’s also the maintenance aspect – not just the run-up to the shelf but the need to maintain a samurai,” he says. “When we have our results published, I see something like eight emails: four from Amsterdam to Tokyo and four back, and then we’re updated. So there is ongoing merit in our view in sticking with Pro-bonds.”

So, in the end, ING was perhaps proven right, and is no longer isolated as an issuer. “These things do take time to bed down in a domestic market,” says Purton at Daiwa. “Pro-bond issuance is three years old, relatively young. It’s true a lot more investors are looking at it, and issuers get the obvious benefits in terms of disclosure, but they don’t get access to uridashis and they don’t get the bonds included in the domestic indices. So there are pros and cons.”

In fact, the latest ING deal was a useful demonstration of the market’s maturity. “Some deals have proven that Tokyo pro-bond can achieve the same level of success as samurai in terms of pricing, size and tenor, but with quicker and more flexible access to yen,” says Tomoyuki Iwasa at Barclays. “A good example was ING’s deal in June, which was a great outcome compared with samurai deals at the same time.”

And perhaps, with that capability demonstrated, this is the time for the market to push forward. “With the recent successes, the market itself is getting more attention from international issuers who do not have a samurai shelf, but want to diversify their funding,” says Iwasa. “We at Barclays are having more inquiries from potential issuer candidates.”

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In order for the Pro-bond market to grow further, two things have to happen: greater recognition of the market as an option for new issuers, and ideally a deepening of the pool of investors who can be reached by it.

Received wisdom has it that one reaches a smaller investor base through Pro-bond than through samurai, though this perspective is somewhat challenged by bankers who work in both. “No, I don’t think so,” says Hayashi at BAML. “Of course retail investors cannot buy Pro-bond, but on big samurai transactions normally we target institutional investors anyway, so there won’t be a big difference.”

Also, it would be wrong to think that there aren’t investors out there just looking for Pro-bonds as a distinct opportunity. “The appetite for Pro-bonds is sometimes investor driven,” adds Amalou at SMBC Nikko. “You do have investors who have dedicated funds to invest in Pro-bonds, and that creates a natural incentive for some issuers who haven’t yet established themselves in a specific format to look at that option.

“Also, there are different ways of approaching the Pro-bond market. Some have ensured the documentation is similar to that of the samurai, using domestic settlement for instance. In that respect, they are sending a strategic message to the investor base. That approach helps minimize the loss of investors we sometimes talk about when we refer to Pro-bond.”

Nevertheless, index inclusion is clearly a key point. Pro-bonds generally do not appear in the major Japanese bond indices, particularly the Nomura BPI, and that limits the number of investors who will buy the securities.

“Having the bonds included in an index would be a big step forward,” says Lee at Maybank.

And several issuers who are put off by a perceived lack of investor diversification in Pro-bond might be persuaded otherwise if that pool was deepened by index inclusion. “If the Pro-bond format can generate sufficient investor demand and it’s also less onerous on the issuer then it’s definitely worth doing,” says Christopher Cornwell, vice president in group funding at ANZ. “However, it comes down to investor preferences, and we find they are chasing samurai more than anything. We will continue to follow that demand, but we’re open to Pro-bond should that call out our name.”

The index issue is, says Hayashi at BAML, “chicken and egg. If there are few issues who use the Tokyo pro-bond market, maybe those bonds will not be included in the index.” More bonds would make it more likely that key indices, notably Nomura BPI, would include them; but more bonds will not be attracted without index inclusion.

“That has always been a major discussion point,” says Hiroyuki Kinoshita, Head of Global Fixed Income Capital Markets, at SMBC Nikko in Tokyo. “Nomura BPI is the most popular index in Japan for yen bonds. They have said the bonds issued in the Tokyo Pro-Bond market would not be included in the index as they judge the bonds would not be public offering bonds, which is a condition for the index.  At the same time, they have said that they would like to monitor market developments such as outstanding amounts, which, some people say, indicate future inclusion in the index.  However, so far, we have not seen any hint that they would open up the index for Pro-bonds.”

Kinoshota adds that accounting is also an important consideration. “It is only this year that the market approved accounting standards for Australia: until then, Australian borrowers were restricted from issuing Pro-bonds,” he says. For Asian borrowers, the accounting standards that are approved by the Pro-bond market are Hong Kong, Singapore, Korea, Taiwan and Malaysia, as well as anyone disclosing their information based on IFRS. “Generally speaking, though, we need to see more available accounting standards if we would like to see more borrowers accessing the pro-bond market.”

So where to from here?

The future is probably more of the same. “At this moment nothing special needs to change, it’s just a matter of name recognition,” says Hayashi at BAML. “The cost is quite cheap and competitive versus other stock exchanges, so promotion will be the key for success.”

BAML itself has filed an issuance programme for Pro-Bond, but, just as with samurai, is unlikely to issue unless a tax law penalising American issuers in Japan is changed. “I have heard that this system may be changed in 2016, so going forward US issuers may think about it,” she says.

So perhaps just a steady accumulation of new names and issues will be enough to propel the market to depth, sophistication and index inclusion. And, failing that, politics may do the trick.

“Met Tokyo is trying to promote this market as one of the symbols of the Tokyo Global Financial Centre concept set out in July 2014, so hopefully the Pro-bond market will be utilised by other issuers, cross-order or Japanese,” says Hayashi.

“Mr Abe and Mr Masuzoe [Yoichi Masuzoe, Governor of Tokyo] are committed to grow the City of Tokyo as a global financial centre, so investors and issuers can expect more of a focus on this market.”