For much of the financial world 2012 will not be fondly remembered. But for Asia’s credit markets it’s been a vintage year.
As Europe has continued to remain mired in sovereign debt crises and the US’s economic recovery had been anaemic, investors around the world have been keen to invest elsewhere. Asia has looked like a good destination, and this demand has helped push bond issuance to record highs.
That’s been music to the ears of banks that are viewed as the best at offering bond market making and rate positions. Added to this an uncertain outlook for energy and raw materials has helped to ensure a steady demand for commodity instruments and derivatives. 2012 has been a good year for banks that can provide these services.
Asiamoney’s second Fixed Income Poll reveals who a large segment of the market believes these players to be.
Overall we received 1,639 valid responses to the poll from a mixture of institutional investors, corporates and financial institutions, a much larger response rate than our inaugural poll received last year.
The voters were effusive in their praise of Citi in particular, voting the US bank top for both its regional credit and its interest rates coverage. Meanwhile BNP Paribas was viewed as the top commodity service provider by the broadest number of poll respondents.
HSBC also ranked well, coming second in credit and third in rates, while Standard Chartered rose to be voted the second-best spot rates house and J.P. Morgan climbed to take third place for its credit coverage, displacing Deutsche Bank out of the top three.
The poll threw up a few interesting results within each of the three categories. Crédit Agricole and ANZ were both viewed as strong houses for their G3 bond research and market coverage for example, while Edwin Chan of UBS was voted the best individual credit research analyst. Moody’s was judged as the best of the credit rating agencies.
Meanwhile DBS stood out for its credit derivatives services, Crédit Agricole was voted top for interest rate derivatives ahead of Citi, and BNP Paribas’ appeal in commodities was cemented on its standing as the best-regarded bank for commodities derivatives.
Citi’s dominance in two of the poll’s categories for the second year comes thanks to the global bank’s strong ties to corporates and investors alike.
That’s not to say that it’s all come without a fight. 2012 has revealed just how important it is to be a strong competitor in Asia’s fixed income markets, which has led to rising competition for market share. Added to this the Basel Committee and regulators in the US have both stipulated a tightening of bank rules, which the bank has had to factor into its coverage plans.
“We have done a lot of work rightsizing the business and making it Basel III-compliant, [along with] the transactions we conduct,” says Nadir Mahmud, head of global markets for Asia Pacific at Citi. “A lot of uncertainties abound, but our business is in much better shape today than it was 12 months ago. Our client coverage has been excellent and we’ve hired the right kinds of people to make further headway.”
Mahmud is keen to emphasise that the US bank’s fixed income businesses are Basel III-friendly. “The rules haven’t yet been enacted but the regulations are changing and we need to be prepared for it.”
He also feels that Citi has areas where it can further improve its regional credit coverage. “We have done well in the rates and currency markets but there continue to be gaps, particularly in the banks space,” he notes.
David Ratliff, head of investor sales for Asia Pacific at Citi, underlines that such opportunities exist. “We’ve a lot more that we can do [to cover the] prime finance space [and] build our hedge funds coverage,” he notes. “We expect further build-out in that space as we continue to develop our business.”
HSBC, this year’s second-ranked house for regional credit coverage, has also been focusing on raising its game in certain pockets of the market.
“In terms of our [credit markets] foundation…we’ve built a very strong base without pockets of weakness,” says Gordon French, head of global markets for Asia at the UK bank. “Over the last couple of years we’ve focused on improving in areas where we were down in the league tables. For example we were a meaningful player in high yield bonds, but not the best.
“We changed this by appointing key people to help us penetrate our commercial banking franchise and adding to our credit sales force and risk appetite for our trading book. This meant that we moved up a notch in those areas where we were previously number three or four or five.”
The focus of this year’s winners on building holistic product coverage makes sense, given that Asia’s fixed income markets have increasingly been a beneficiary of the troubled economic times plaguing the world.
While other regions have fallen into recession or struggled to retain growth, Asia’s larger economies have all enjoyed strong and continued expansion, which has raised their allure, particularly as Western economies have cut rates to stimulate growth.
This has both increased liquidity and encouraged more debt issuance, as regional governments have raised bond issuance to pay for fiscal spending in order to keep their economies strong, while Asian companies have seen an increased reluctance among many international banks to lend money counterbalanced by an increased desire of international investors to buy bond issues.
This has led to a swift deepening of the region’s credit and rate markets.
“Asian markets have seen a great deal of development since the global financial crisis in 2008, which has improved depth of the market, liquidity and breadth,” says Teh Yeong Chuan, global head of rates at Standard Chartered.
He notes that the development of long-dated bond curves has aided this trend, with South Korea and Singapore for example both posting 30-year bonds for the first time and Thailand re-opening a 50-year transaction.
French notes that the uncertainties of the global economic environment and these extended yield curves led borrowers to try and raise long-dated money quickly this year.
“From the beginning of the year borrowers were coming out proactively to ensure they got as far out in terms of tenor as they could and got their funding in place as the macroeconomic environment was unsteady.”
The emphasis on longer tenors has combined with some compelling foreign exchange returns and the benign growth forecasts of Asian economies to make regional credits an appealing investment option during 2012. It’s an investment trend that has only been increased by quantitative easing efforts in Europe and most recently the US for the third time.
Added to this central banks in Asia have had large and mounting foreign currency reserves that they have had to hold in instruments, and the difficulties surrounding the euro have made it clear how important diversification of such funds is. So they have increasingly had an interest in gaining exposure to reputable regional credits, frequently on a longer-term basis.
Sovereign wealth funds have also been sizeable buyers of regional fixed income instruments.
“Over the last couple of years, we’ve seen a big pickup in interest in the credit markets as well as local currency bond markets in Asia,” says Ratliff. “There is still a lot of focus on the G3 debt markets, but the local rates and credits have been expanding as a business too.”
He notes that to meet these rising needs Citi has been bolstering its local currency bond sales and trading efforts, in part by relocating people from Europe and the US.
The strong economic and fiscal positions of Asian countries combined with the volatility elsewhere, particularly in the latter half of 2011 when the US was downgraded to ‘AA+’ by Standard & Poor’s, have convinced international investors to put more money to work in Asian bonds.
“These factors have helped the region’s capital markets grow tremendously, with liquidity rising a lot and the bid/offer spreads narrowing a great deal,” says Teh.
Liquidity and efficiency
One example of this is Malaysian government bonds, which used to trade at bid/offer spreads as wide as 300 to 400 basis points (bp) a few years ago, but now have a trading spread of just 0.5bp. Similarly the Philippines’ sovereign bonds have seen their bid/offer spread drop from 15bp-20bp down to 3bp.
Tighter trading levels have helped attract yet more investors, and helped further expand the region’s bond markets.
Dealogic noted in a report in early October that the first nine months of 2012 represented the highest level of bond issuance from Asia ex-Japan on record for that time period, with US$582.2 billion being issued by regional companies. The majority – US$476 billion – was conducted in the local currency bond markets.
South Korea offers a good example of the rising appeal of Asia’s local currency bond markets. The country possesses the largest freely accessible bond market in the region with a daily turnover that frequently reaches US$10 billion. That’s around 50% higher than seen in 2011 and 2010.
Teh notes that a combination of the FX and capital gains returns on some Korean government bonds would have returned investors more than 9% so far this year, an appealing level of return given the low returns offered by many US and European credits.
Singapore, a ‘AAA’-rated country, has offered an effective rate of around 8% on some of its debt for similar reasons.
Any bank with ambitions of being a major fixed income player has sought to take advantage of these benign conditions.
All the winning banks that Asiamoney spoke to boasted about the fact that they had worked hard to develop their market-making capabilities in the bond market, which includes having sizeable sales teams and holding decent inventories of bonds to meet the needs of large investors like central banks.
This also involves keeping a global presence for non-Asia investors. “We have selectively increased sales teams in London and New York to cover central banks, sovereign wealth funds and real money accounts, while we have a trade in New York that makes a market for local currency bonds and derivatives,” says Teh.
It’s not just straight credit investors seeking to play either; a number of investors unable to directly invest into Asian bonds due to documentary restrictions have sought to play the region’s swap markets instead.
“The swap markets are a good proxy for the bond markets for hedge funds, and more and more of them are trading Asian rates because of documentary restrictions over them directly buying bonds,” says Teh. “Plus NDF [non-deliverable forwards, a form of derivative used to speculate on currencies that have no official futures market] volumes have also gone through the roof in relation to what we’ve seen in the bond market.”
The impressive rate of growth witnessed in Asia’s credit market is something that will be hard to top in 2013. For a start there is the ongoing uncertainty in the world’s macroeconomic environment. China’s economy looks like it is set to slow markedly.
Combined with the ongoing troubles plaguing Europe and a weak recovery in the US, many of the traditional drivers of Asia’s economies are falling away, meaning that the region’s countries could see GDP growth slip.
Added to this, Asia has in part been a victim of its own success. Credit spreads have performed extremely well during 2012, but this has led to a point where Asia bonds are looking well priced against alternative investments in other parts of the world. Investors increasingly see that there is little more easy money to be had in the region.
These factors risk scuffing the region’s burnished image and leave investors feeling less need to buy regional bonds.
Yet despite these headwinds, this year’s winners are reasonably confident that Asia as a region will weather the economic difficulties of other areas.
“During the last cycle Asia’s central banks went on interest rate hikes due to fears of inflation so they have the flexibility to reverse this, as many have been,” notes Teh. “Almost every country has some capacity to stimulate growth in the region, such as conducting fiscal spending or interest rate cuts. I think the economic growth picture will remain in place next year, even if it slows a little from recent years.”
Mahmud of Citi agrees. “My sense is the markets will expand. Look at the global fixed income markets, part of trend of last two years has been that G10 and G3 rates are collapsing and heading towards zero, so investors looking for yield have had to look at other markets.
“Also there are more funds looking to diversify currency exposure and into something that’s a little safer and so heading to local markets. The Brazils or Koreas are benefiting as a result, from flows from outside [their respective regions] and intra regional flows too.”
The bankers certainly think reasons still exist as to why investors should put money to work in Asia.
“If we get economic stability in Europe and the US’s fledgling recovery doesn’t go off track we could see further rallies of fixed income markets around the world,” says Citi’s Ratliff. “That will benefit Asia; a lot of 10-year bonds in the region are around 3% yields, whereas 10-year yields in Brazil and Mexico are close to 2.5%, and they are close to 2% throughout Latin America.”
Added to this, Mahmud says that continued interest from some of the world’s largest investors should propel demand for Asia’s top sovereign bonds.
“The region’s central banks and sovereign wealth funds are diversifying, with Asian central banks buying each other’s bonds. This diversification is 40% or 50% of the way towards completion and will carry on.”
HSBC’s French notes that ultimately the increased interest in Asia’s fixed income markets looks set to stay because of the region’s unique appeal.
“Look at Asia’s growth demographics, the developing wealth industry in the region and the fact that Asians are trading both a lot more fixed income funds and single names; plus there is obviously the hunt for yield in a zero rate environment, which won’t disappear any time soon,” he says. “You’ll have moments in time when equity markets rally, but I think that a super cycle is in train, where people have changed their investment behavior and adopted more FX and credit classes.”
A strong year for Asia’s fixed income markets has cemented its importance in the role of global investors, be they central banks, institutional investors or hedge funds. It’s unlikely that 2013 will witness a momentum quite as favourable, but the development of the region’s fixed income markets will go on. And it looks set to keep gaining the attention of the world’s leading investors.
The banks that can do the best job meeting that need stand to do very well indeed.