East Asia's bond markets may be set to grow to over $1 trillion by 2004, as the World Bank predicts. And they may be, as one analyst puts it, "the final frontier for the world's investment banks". But right now they are in a primitive condition.
A list of the difficulties of issuing and investing in them makes sober reading antiquated settlement systems, short or non-existent yield curves, unfavourable tax treatment, poor liquidity and a lack of both supply and demand for paper.
Currently, the challenge for banks is to link up borrowers and investors and give both as smooth a ride as possible through often choppy seas. But to give the market what it wants, bankers must understand Asia's business background and why some products succeed while others stumble.
The plain-vanilla fixed-rate bond of medium or long maturity is something of a bit player in Asia. Governments tend to be flush with money and to run surpluses, and what issuance they do undertake is of the short-term money market kind. Traditionally, Asian corporates have relied on bank loans and equity for fund-raising and fought shy of the disclosure demanded by bond issues. In this environment, floating rating notes (frns) and convertible bonds have taken off while fixed-rate bonds have been slower to establish themselves. frns have catered to banks' needs to match floating-rate liabilities while convertibles have satiated the desire of both issuers and investors for even fixed-rate offerings to have an equity component.
Despite this diffidence towards the pure bond, Asian bond markets in all their different guises closed domestic markets such as South Korea and China, open domestic markets such as Hong Kong, offshore markets in Asian currencies such as Thai baht and Indonesian rupiah, and international offerings by Asian issuers are growing. Banks in the region are responding by putting together structures that mitigate or resolve the on-the-ground problems.
"The bond markets in Asia have grown very rapidly over the last four or five years," says Andre Lee, managing director of Peregrine Fixed Income, one of the leading players in Asia. "The same detractors you have today [those who say Asian bond markets are too small and too handicapped to be important] are the same detractors you had four years ago. In the meantime, the market has doubled in size."
"If you compare Asian bond markets with the us treasury bond market or the [German] Bund or JGB [Japanese government bond] markets then certainly there is a long way to go. But I would argue that at a similar stage of development those markets were just as illiquid and the same problems existed."
One of the most significant problems one that is often overlooked is the paucity of Asian-based fixed-rate investors. Institutional investors such as pension and insurance funds are new to the region. Welfare in Asia's traditional societies has been a matter for the family, not the state, and the Chinese have regarded life insurance as a preparation for death and therefore a bad omen. With modernization attitudes are changing, however, and Asia's huge savings pool is slowly moving out of mattresses and bank accounts into longer-term vehicles. Malaysia and Singapore have taken the lead in establishing provident funds and Hong Kong will follow next year. Only gradually are buyers of fixed-rate paper making their presence felt, a critical development for the market.
"One of the key issues is to develop demand [for bonds]," says Edward Young, managing director of Moody's Asia Pacific. "People have focused on the need for governments to issue and the need for efficient settlement systems, but we have been raising our hands and asking: 'Who is going to buy it?' "
And who is going to issue? Governments don't need the money and the traditional Asian family business is debt-averse, preferring to finance growth out of cashflow as a first choice, and then as a last resort by bank borrowings. The banks themselves are awash with liquidity, provided by Asian savings, and keen to lend at rates that compare favourably with those that most corporates can attract in either domestic or international bond markets. Since many Asian corporates are unknown outside their home countries and have little or no issuance history their spreads usually are wider than similarly rated European or US corporates.
"The cross-border market is predominantly a banking market because it's cheaper [for the borrowers]," says Moody's Young. "Three- to-five year money from banks is cheaper than bonds for many issuers. It's easier to call up the bank and get the money. There is no disclosure requirement and no need for a roadshow or a rating."
Nigel Myer, head of origination at NatWest Markets in Hong Kong, says: "Corporates sit and listen [to the case for bonds] but at the end of the day they take the cheapest money, which is often bank loans, although there is evidence that this is changing."
A rough breakdown of Asian corporate debt shows that 80% is accounted for by bank borrowings with the balance divided between fixed-rate bonds and convertibles. In Europe the split between syndicated loans and bonds is closer to even. Things are changing, but slowly.
"The old Asian formula of syndicated loans and equity is shifting. There is a growing realization that it doesn't make sense to be just dependent on the banks, and issuers also want to have a profile outside of Asia," says Chris Van Niekerk, executive director of debt capital markets in Asia for SBC Warburg.
Perhaps the greatest fillip to Asian bond markets would be a full-blown banking crisis. This is not as unlikely as it sounds. Years of rapid lending growth in frothy economies have piled up non-performing assets. In Thailand, where the stock market is depressed, the problem is most acute. Korean banks' non-performing assets are put at 8% of total lending. But while troubles in the banking sector might push corporates towards the bond markets, they would also injure some of Asia's most prolific issuers and holders of FRNs the banks. That might hold back market development.