One of the clearest lessons of the Asian financial crisis has been the danger of companies relying on poorly supervised and ill-run banks as their sole source of funding. Diversifying capital sources by building up local securities markets is a standard prescription for Asia handed down from international bodies such as the IMF and market practitioners everywhere. This year, such debt markets have been taking off, notably in Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand to complement the already established Hong Kong dollar market.
There are clear advantages for local investors and corporate risk managers in developing such local sources of funding. Earlier this year, HSBC Markets led a M$500 million (US$132 million) eight-year fixed rate bond for Malaysian energy company Tenaga. “Previously, Tenaga, which has 100% of its revenues in ringitt, had all of its debt liabilities in foreign currency,” says Mark Bucknall, global head of debt capital markets at HSBC Markets. “At the same time you had Malaysian insurance companies crying out for ringitt assets which had only government paper to buy. So when you offer them Tenaga at a small spread to governments, they love it.” HSBC points out that it has done bond deals this year in Malaysian ringitt, Indonesian rupiah, Thai baht, Philippine pesos, as well as Singapore and Hong Kong dollars. Beyond the highly visible international US dollar-denominated bond markets, there is an upsurge in volumes in local markets and private placements across the region. “On the debt side this year, we have done 336 transactions, down from the US$1 billion 10-year deals for KCRC [Kowloon-Canton Railway Corp] to the HK$5 million private placement of a bank CD programme,” says Bucknall.
Even in the comparatively well-developed Hong Kong dollar bond market, new forces are at work. In the boom years in Asia from 1994 to 1997, corporates hardly ever issued local-currency bonds since banks were falling over themselves to lend cheap money. Investors who grew used to seeing stock markets appreciate by 30% a year had little incentive to invest in bonds yielding 8% particularly when the inflation rate was 7%. During the crisis however, stock markets lost 50% or more, inflation rates went to zero and interest rates rose. Bonds suddenly became interesting.
At the same time, investing institutions have grown up in the region, such as the Mandatory Provident Fund in Hong Kong, that ideally should invest a proportion of their inflows in fixed income. It is still, though, a matter of some frustration to debt traders in Hong Kong that no specific asset allocation to debt has been prescribed for the provident fund.
It remains unclear how successfully the local bond markets will compete with international capital markets for Asian capital-raising. Already the local markets offer certain borrowers pricing and maturities they find attractive. “Thai companies can get more attractive funding through Thai baht bonds in maturities up to five to seven years,” says Samuel Poon, managing director at Merrill Lynch, “and Hong Kong property companies can happily take five-year Hong Kong dollar money to fund three- to five-year property developments. The international market is there for longer-term strategic funding,” says Poon. In Korea, the banks are spending most of their time working through the debt of the chaebol (big conglomerates) and, though they are not in lending mode, have been given guidance by the government to spend time working with medium-size companies. “In addition to the government related institutions, larger Korean corporates can borrow in the local bond market,” says Glenn Kim, managing director at Lehman Brothers.
Marc Jones, managing director at JP Morgan says: “Local market appetite is developing where interest rates are low and savings rates are high. Thai corporates have done many deals in Thai baht. However, for local market financing generally, the depth is not there and building market infrastructure remains a challenge.”
Though some international firms are dipping into the local markets, these are likely to remain the province of the local banks. It’s too costly for international firms to set up research, sales, trading and origination in each country, when those firms have only just finished retrenching in Asia. Local banks tend to have greater regulatory flexibility in local markets and greater capacity to underwrite local-currency issues and sell them out slowly. Local investors will remain the predominant buyers. “It’s already a stretch to get international-minded bond buyers like Alliance Capital and Prudential to buy Hong Kong dollars. The smaller markets in Asia will never have the liquidity to attract these buyers,” says one banker. “The Taiwan market will only ever appeal to local institutions. And even while Hong Kong and Singapore have made the greatest strides, I don’t know any investors outside Singapore who are natural holders of Singapore dollars. All these S$100 million deals are disguised bank loans.”
The attempts of the Singapore authorities to develop their local bond market have attracted considerable attention this year, not least for the bizarre appearance of the central bank, the Monetary Authority of Singapore, previously renowned for keeping such a tight rein on the Singapore dollar, touting so openly for business. In the past, foreign borrowers were forbidden to issue Singapore dollar liabilities, now they are being almost badgered to do so. One sceptical observer says: “One of the international borrowers that did a Singapore dollar deal this year had no real desire or need to. But it was part of the price with the Singapore authorities for establishing a regional headquarters there.” The MAS has also encouraged local Singaporean quasi-government issuers various statutory boards to issue.
By the end of the third quarter of this year, Singaporean corporate issuance had reached S$15.9 billion (US$9.5 billion), almost twice 1998’s S$8.7 billion, and the MAS is eager for more. Low Kwok Mun, director of the monetary management division of the MAS, says: “We continue to see interest from foreign companies wishing to issue Singapore dollar bonds. Some have already been given in-principle approval to issue and are just waiting for the right timing to do so. Normally our approval process takes no more than three to four days. in which our main focus is on the bond structure and how the issuer intends to swap out the S$ proceeds into foreign currency.”
The MAS knows full well that few foreign issuers have Singapore dollar requirements and will hedge their liabilities. In the past short selling and currency swaps involving the Singapore dollar were closely regulated and it is a sign of the eagerness in Singapore to promote local bond markets that a more lenient attitude to swaps is emerging. “Issuers and banks have noted the need for a more liquid long-term swap market and we are looking at ways to facilitate that,” says Low. One step being considered is granting a tax concession on trading income from swaps. “We have recently announced the exemption of swaps of more than one-year maturity from reserve requirements,” says Low.
Yet it remains an open question whether the Singapore dollar market, which so far has seen most issues from international borrowers such as the European Bank for Reconstruction & Development and UK bank Abbey National and a few local corporates such as Singapore Cable Vision, will become a practicable source of funding to Asian companies. The MAS internal rating guideline that only investment-grade borrowers can issue is a substantial obstacle, though this is now under review. “We are reviewing it with a view to relaxing the guideline to facilitate issuance of S$ bonds by regional borrowers, not many of which have investment-grade ratings,” says Low.
It would be unwise for regional rivals in Hong Kong to underestimate the determination of the Singaporean authorities and banks to work together to boost Singapore as a regional financial centre. Financial services is a mainstay of the economy. It has suffered a serious loss of business through the crisis. Some of the biggest customers of Singapore banks’ huge currency dealing desks were second-tier regional banks and hedge funds and both groups have disappeared, perhaps permanently. Singapore won few friends in the region for being the currency-dealing centre in which several countries’ currencies were broken but which fiercely protected the Singapore dollar.
Now Singapore is fighting hard for business. It has announced long tax holidays for asset management groups and some are being attracted by this and the prospect of another sweetener: the chance to manage the Singapore government’s own money. The MAS is putting out S$10 billion of its own funds to be awarded to external fund managers for the next 10 years and the Government Investment Corporation (GIC) is putting out a further S$25 billion over three years. Again it remains to be seen whether this will kick-start a large fund-management business in Singapore. Low says: “This is seed money to give a boost to the asset managers located here. Asset management groups don’t come here just to manage these Singapore government funds. They also attract funds from Europe the US and the region to manage. Hopefully American and European money will come here to be managed as markets in the region recover.”
To sceptical observers in the north of the region the Singapore dollar bond market looks like an artificial creation of questionable viability to issuers and investors. It is not easy to wish markets into existence.
Hong Kong has been striving to develop and diversify its own local-currency bond market. One key institution has been the Hong Kong Mortgage Corporation, loosely modelled on the American federal agency Fannie Mae. The HKMC is a Hong Kong government-owned corporation with a mission to promote home ownership, help stabilize the banking system and develop the local debt market as an issuer in its own right and as the creator of a mortgage-backed securities market.
Conditions in the Hong Kong market have not been entirely conducive to this. Local banks are locked in intense competition to originate and hold residential mortgages. This rivalry has grown so fierce that the Hong Kong Monetary Authority has recently warned against excesses by banks seeking to lure away competitors’ clients with cheap mortgage refinancings. Banks have no desire to sell mortgages to anyone, including the HKMC.
“We are a commercial organization. It’s no good just standing still, we have to do something imaginative and innovative,” says Philip Li, senior vice-president for finance at the HKMC. Li is outlining a recent transaction where it bought a HK$1 billion (US127 million) portfolio of mortgages from Dao Heng Bank, created a special-purpose vehicle to issue mortgage-backed securities against the portfolio and then sold the whole deal back to Dao Heng. A pointless round-tripping exercise?
Not so, says Li. “The benefit to us is that we get a guarantee fee from the bank. The benefit from the selling bank is that it does not lose the assets but now sees the associated risk capital weighting reduced from 50% against the original mortgage loans to 20% against the public-sector HKMC guarantee. The mortgage-backed security is not classed as property exposure and that releases capital for the bank to generate more business.” Mortgage-backed securities can be classed as liquefiable assets because there are committed market-makers: Deutsche Bank, JP Morgan, Merrill Lynch and Dao Hang itself.
Li argues that the banks’ obsession with residential mortgages will be short-lived. As the economic cycle turns, they will once again lend to corporates and be happy to sell mortgages to the HKMC. Those that have used the HKMC to bundle their portfolios into mortgage-backed securities will find these easier to sell. Several other banks are now considering similar deals. But until the cycle does change, there will be little momentum from the big banks to provide liquidity to the mortgage-backed bond market. The treasurer of one Hong Kong bank says: “Yes we own some mortgage securities. We would like other banks to own some so we can trade them around. But why should I buy into this market to release capital to my competitors so they can turn around and undercut me on new loans.”
The lack of mortgages to buy, and high pre-payment rates on existing mortgages, has also held back the HKMC from becoming a leading issuer in the local debt markets. Its sources of funds are HK$2 billion of government equity, the short-term money markets, HK$10 billion of back-up bank revolving credits and, its preferred source, local bond markets. It has a HK$20 billion note-issuance programme. But new issue are tied to the volume of mortgages it buys and it has bought only HK$2 billion this year.
Li is also conscious of the HKMC’s potential role in developing the local capital market. “Asia, including Hong Kong, has always been seen as a venture-capital market. People start companies, raise debt from the banks and sell shares to the public. In the early 1990s, the Asian economies enjoyed high growth that demanded a huge amount of money for infrastructure; ironically, there was an outflow into G7 bonds since there was not much debt investment domestically. Developing local capital markets has been a hot topic for some time.”
There are interesting parallels with Europe here. Only after the creation of the euro has Europe developed a large corporate bond market. Before the euro, there were small splintered local-currency bond markets, with only a few of meaningful size. Asian monetary union in such a politically, economically and culturally diverse region is a vision that could materialize only decades into the future. The Japanese yen might have become the currency of Asia, but the Japanese authorities have had little interest in promoting it as such.
Instead the US dollar is by default the only likely common currency for an Asian bond market. Although small local-currency markets are emerging, the most encouraging trend many bond market participants have seen this year is the growing demand from Asian investors to buy Asian credits in dollar form. It’s a big change from before the Asian crisis when bonds rarely traded in Asian time and new issues roadshowed more assiduously in America than in Asia.
“Before the crisis, US investors were holding Asian issuers hostage on price as they were often the only bid, especially for 10-deals. But this year there have been more buyers in Europe and Asia. The Hutchison €500 million [US$549 million] seven-year deal was sold mainly to Europeans and the KCRC $1 billion 10-year deal to Asians and Europeans,” says Bucknall at HSBC. Cordeiro makes a similar point about the Goldman Sachs-led deal for Ayala. “Asian buyers of Asian credits in Asian time albeit in dollars that is a step in the right direction.”
