Foreign issuers flock to the domestic yen market

European and US borrowers have raised more than $20 billion in the domestic Japanese bond market so far in 2003. Issuance is expected to rise further this year as demand increases.

Japan's domestic bond market has been a reliable source of cheap debt for highly rated European and American borrowers since the 1980s. However, issuance fell slightly in 2002 because of investor uncertainty about the direction of the Japanese economy. The market has been significantly busier in the first quarter of 2003. Over the past five months, international borrowers such as German development bank KfW and the Nordic Investment Bank have raised more than $1 billion a week in the market.

Most of the issues have been structured notes linked to the direction of the yen/dollar exchange rates, and interest rate differentials between Japan and the US. These bonds are popular with Japanese investors because they yield more than local domestic bonds.

Some Scandinavian companies such as SEK and SNS Financial Markets are now borrowing more than half their MTN funding requirements in Japan. German Landesbanken are not far behind.

GMAC, GECC, Peugeot, NIB Capital, BMW, Volkswagen, HBOS, France Telecom, the New South Wales Treasury Corp and Ford Credit have all tapped the market so far this year, as have less frequent issuers such as the National Grid, the Hypo Tirol Bank, Teijin Holdings Netherlands and Bradford & Bingley.

Many of these firms have been able to raise debt in Japan for as little as 10 or 20 basis points below Libor - significantly less than their funding costs in the international markets even when the higher administration charges involved are taken into account.

Debt syndicate heads in London and Tokyo are confident that this trend will continue during the second half of 2003 as retail and institutional investors continue to switch out of Japanese government bonds (JGBs) into higher-yielding securities.

"There has been a strong rally in JGBs, and investors are becoming reluctant to continue buying at these levels," says Jack Gunn, head of debt syndicate at Merrill Lynch in Tokyo. "They are gravitating to structured notes, which offer higher yields."

The most popular structured notes are likely to remain those that enable investors to take a view on the yen/dollar exchange rate - an issue of much interest in Japan. "You can stop a man in the street and he will know the US dollar to yen rate. He probably won't have a clue about the Nikkei but he will know about the dollar," says a London-based banker.

Bonds that offer interest rates linked to the yen/dollar rate have proved popular so far this year. The Nordic Investment Bank (NIB), for example, raised ¥1 billion of 20-year debt by issuing these kinds of bonds.

Austrian bank Oberösterreichische Landesbank was reported to have found plenty of buyers for its ¥500 million ($4.3 million) 20-year deal launched the following month. This had a fixed interest rate for the first year but a variable one linked to the exchange rate thereafter.

The rate has not been easy to predict this year. Having strengthened against the US dollar from 122 to 118 during the first three months of the year, the yen weakened during April after military action in Iraq only to settle back to 117 in May.

And it looks as if it will be harder in the coming months, with some analysts saying that the yen should trade at 150 to the dollar and others that its "natural" home is in the 100 to 110 range.

Perhaps because of this uncertainty, some Japanese investors seem keener on notes linked to the exchange rate between the yen and the euro. One deal done recently exploited this desire by offering an interest rate that went up in line with the euro.

Notes structured around the difference between Japanese and international interest rates are also popular.

In May 2003, the Banque et Caisse d'Epargne de l'Etat Luxembourg issued a ¥800 million forex step-up reverse FRN hybrid that pays semi-annual interest of 1.5% until the final year when it pays 4.86% minus Libor.

The callable reverse floater note is also being tipped as a sellable structure. These notes enable investors to bet that interest rates in Japan will stay low for longer than the forward curve implies.

Samurai bonds are expected to prove popular with Japanese investors in the coming months. There haven't been many deals since Italy's ¥100 billion issue in March 2002. Meanwhile, a fair number issued in the 1990s are due to mature in 2003 and 2004.

Poland has mandated Daiwa SMBC Securities to launch its inaugural samurai bond according to Euroweek magazine. Croatia is also reported to be interested. Both issuers will need to be careful about pricing. Earlier this year, IBM was said to have encountered some difficulties with its ¥26 billion offering.