Heightened volatility in the Japanese Government Bond (JGB) market following the BoJ’s stimulus announcement in April does not appear to have prompted widespread selling by overseas investors, which have been progressively adding to their holdings in recent years.
“For investors looking for safety, high liquidity and low volatility, the best options are still clearly the US Treasury and JGB markets,” says Satoru Shibata, director for debt management and investor relations at the Japanese Ministry of Finance (MOF) in Tokyo.
MOF data on the ownership of JGBs indicates that between March 2010 and September 2012, the share of foreign investors rose from 5.6% to a peak of 9.1%, before slipping back to 8.6% in December 2012 and 8.4% in March 2013. According to Shibata, since 2010 Chinese investors have been the largest overseas investors in the Japanese bond market, increasing their holdings by over 14% in 2012 alone.
Shibata says that the MOF is encouraged by growing participation by Asian investors in the JGB market. In March 2012, domestic banks accounted for 42% of the market. The MOF is keenly aware, says Shibata, that this concentration leaves the market vulnerable to mass selling (or buying) by a single investor group. “This is why the issuing authorities have made efforts to diversify the JGB investor base by promoting increased participation by retail and foreign investors which have different investment behaviours from those of domestic financial institutions,” he says.
Yield deterrent
For most, however, pitifully low yields in the JGB market remain a powerful deterrent. The inflation-linked market may be a more popular option for overseas investors, as and when more liquidity is added to a market that is mistrusted by domestic institutions. The MOF is planning to resume JGBi issuance in October, beginning with ¥600bn of 10 year new-look bonds incorporating a deflation floor in the first fiscal year.
Shibata expects inflation-linked JGBs to appeal to foreign and domestic institutions alike, but Tokyo-based bankers are not so sure. “Foreign investors, especially those in the UK, love inflation-linked bonds,” says Tetsuya Miura, chief bond strategist at Mizuho Securities in Tokyo. “But regional banks lost a lot of money on the market following the Lehman shock, so appetite from domestic investors may not be as strong.”
Shun Nakamura, director of debt capital markets at Daiwa Securities in Tokyo, says that among conservative Japanese institutions, the preference for those in search of higher yields is to move down the maturity curve. “Investors that used to buy five years are now buying 10s, while those who bought 10s are now buying 20s,” he says. “They are doing so mainly in the JGB market, but they are also looking to extend in the municipals and agency markets.”
Another option, popular with domestic institutions with dollars to invest but generally discouraged by borrowers and their intermediaries, is to buy into foreign currency debt issued by Japanese agencies. Bankers report that a number of recent dollar benchmark bonds targeted at overseas investors have flowed back to Japan.
The closest proxy to the government in the global capital market is Japan Bank for International Cooperation (JBIC), which today is the only public sector borrower which enjoys an explicit government guarantee on all its international bonds. The result, as JBIC reiterates in its most recent investor presentation, is that it “provides an opportunity for Japan sovereign exposure in non-yen currencies through investment in JBIC foreign bonds.” The same presentation emphasises that “any change of the ownership structure or privatisation of JBIC, even partially, is not contemplated.”
JBIC benchmark
As well as being its largest ever transaction, JBIC’s most recent dollar global was the biggest government guaranteed global bond ever launched by a Japanese borrower. Led in July by Barclays, Daiwa, Deutsche Bank and Goldman Sachs, JBIC’s $3.5bn issue was a two-tranche global split into a five year $2.5bn bond priced at 37bp over mid-swaps (56.6bp over US Treasuries) and a 10 year tranche at a 68bp spread to swaps. “The issue generated about $5bn of demand in total, so a larger transaction would have been possible, particularly in the five year tranche,” says Christopher Brown, managing director and head of fixed income at Daiwa Capital Markets in London. “But JBIC capped the issue at $2.5bn in the five year and $1bn in the 10 year.”
The pricing of the JBIC bond stoked controversy among some market observers who argued that it amounted to a chunky 15bp concession to the borrower’s secondary curve. Brown, who says that the concession was probably closer to 7bp, says that criticism of the pricing is unfounded. “Pricing obviously needed to reflect the uncertain market conditions following the Bernanke comments on US monetary policy,” he says. “The pricing of the shorter tranche was curve-adjusted based on JBIC’s outstanding five year bond, but people who say the concession was too high seem to have forgotten that there is a difference between a July 2017 bond and a 2018 new issue. So after some allowance for the curve there certainly wasn’t a 15bp concession.”
The pricing of the longer tranche, Brown adds, was inevitably more complicated given the absence of any comparable government guaranteed issue in the 10 year maturity. “We used recent issues from borrowers such as Quebec and BNG as reference points for the 10 year tranche, and decided that the correct slope between JBIC’s five and 10 year issuance was about 30bp,” he says.
Brown insists that there were several reasons for the success of the recent JBIC benchmark. “It looks like a straightforward deal but it was the subject of considerable discussion in the weeks before launch because of the volatility in the market and the reluctance of investors to participate in new issues after the Bernanke comments,” he says.
At Deutsche in Tokyo, Mori says that the JBIC issue was effectively a re-opener for the longer end of the SSA dollar market. “In the eight weeks prior to the JBIC trade, most SSA issuance in dollars was either short-dated or in FRN format, so it was a brave move to issue in 10 years,” he says.
“One of the reasons for the deal’s success was that Japanese government guaranteed borrowers are still relatively infrequent issuers in the dollar market,” says Brown. “Additionally, the two-tranche format is unusual for a Japanese government guaranteed issuer. Although the five year tranche of course appealed to the broadest range of investors, the 10 year issue was targeted at a different investor base that was looking to capitalise on the higher underlying yield and the wider spread it offered.”
From the borrower’s perspective, the 10 year tranche also allowed JBIC to build on the initiative of extending its yield curve in dollars, which it began at the start of 2012 when it issued a seven year benchmark.
This fiscal year, JBIC has a funding requirement of ¥660bn which, as Brown says, leaves plenty of room for further issuance later in the year.
Rare DBJ
Among Japan’s other public sector borrowers, Development Bank of Japan (DBJ) also continues to fund in government guaranteed benchmark format in the international market, where it issued $1.5bn last year. Its most recent international transaction was a $1bn Reg S/144A five year transaction in January which was able to capitalise on the relative scarcity value of government guaranteed issuers in the international market. Led by BAML, HSBC and JP Morgan, the DBJ benchmark was priced at 24bp over mid-swaps, with 59% of the bonds placed in Europe, 18% in Asia and 17% in the Americas.
Yasuhiro Matsui, director of the treasury department at DBJ in Tokyo, says that the bank’s profile in the international capital market is different to JBIC’s in two key respects. “First, with a non-yen funding requirement that is smaller, it is difficult to match JBIC for issuing size that is one major element of liquidity,” he says.
Second, unlike JBIC, DBJ has been earmarked for privatisation for several years. Matsui says that there has not yet been any firm indication one way or another as to whether the present government wants to push ahead with the privatisation of DBJ, which is playing an important role in helping to finance some of the alternative energy projects that are a notable component of Abe’s third arrow. “Discussions on the privatisation schedule might begin early next fiscal year,” says Matsui.
In the meantime, the bank has started to test investor appetite for exposure to DBJ on an unguaranteed basis. In April, it launched its first US dollar internationally-targeted non-guaranteed trade, in the form of a $250m two year floating rate note (FRN) led by BAML and Barclays. Matsui concedes that he was not entirely satisfied by the outcome. “We were hoping to see more new foreign investors in the book, because the two year maturity was chosen to ensure that they would not have to worry about the privatisation schedule,” he says. “But we did not see so many investors in the book. That may have been because overseas investors did not have enough time to familiarise themselves with DBJ’s credit, unlike Japanese investors.”
Beyond guaranteed and unguaranteed issuance in dollars, DBJ is exploring a range of alternative funding sources outside the yen market, reflecting its increased lending overseas. In April, it set up a $300m Euro-commercial paper (CP) programme, while in the private placement market it has raised close to €140m this calendar year. “Our next target is the sterling market, and we are also considering issuing in Australian dollars,” says Matsui.
Unguaranteed JFM
Japan’s other regular issuer in the international capital market, Japan Finance Organization for Municipalities (JFM), is making the transition towards offering all its new benchmarks in unguaranteed format. In FY2012, overseas bond issuance accounted for $2.7bn of JFM’s total unguaranteed funding for the year of $16.2bn — of which $2bn was in benchmark bonds, $557m in three private placements and A$100m in Uridashi format.
“In FY2013, we have an unguaranteed funding requirement of $15.9bn, of which $2.3bn will be in overseas bonds,” says Masahiro Takenaka, director of finance in the finance department at JFM in Tokyo. “So far this fiscal year we have raised $605m in the private placement market. Our aim is to issue at least one benchmark transaction each year, but we will issue two if market conditions allow.”
JFM launched its first unguaranteed benchmark in September 2012. Led by Bank of America Merrill Lynch, Barclays and Nomura, the response to this $1bn five year transaction was testimony to the strength of international demand for top quality Japanese names without a government guarantee. Priced at the tight end of guidance, at 73bp over swaps, this landmark transaction generated total demand in excess of $2.5bn.
JFM returned to the dollar market in unguaranteed format in January 2013, pricing a five year $1bn Reg S issue via Barclays, Deutsche and Mizuho at 45bp over mid-swaps.
Among the individual municipal borrowers, only Tokyo Metropolitan Government (TMG) has been active in the international capital market in recent years. In January 2012, it issued in the dollar market in unguaranteed format for the first time, printing a $650m five year bond via Bank of America Merrill Lynch (BAML) and Deutsche Bank. Since then, Tokyo has returned to the dollar market twice, issuing in a larger size and at a tighter price on each occasion.
TMG’s most recent dollar transaction was notable for the strength of demand it generated in a weak global environment in which investors were becoming increasingly unnerved by the prospect of quantitative easing tapering in the US. In spite of these concerns, TMG’s $1bn five year transaction, led by BAML, Barclays and Nomura, was priced at a 1.625% coupon, or 68bp over US Treasuries, which compared with coupons of 1.875% and 1.75% for its previous dollar benchmarks. Pricing on the Reg S issue was tightened in response to strong and well diversified demand, just over half of which was from Europe, with 46% coming from Asia and 3% from the Middle East. Banks accounted for 53.5% of the book, with asset managers taking 28% and central banks and official institutions, 6.5%.
Good TiMinG
Tetsuya Kodama at Barclays in Tokyo attributes the success of TMG’s recent dollar issue to careful marketing and a comprehensive roadshow — which included a first-time visit to investors in the Middle East — combined with good timing. “The transaction was timed just before the market became completely wobbly,” he says. “The clouds were gathering, but we came through just before the heavens opened up in terms of US rates and spreads jumping up.”
It is no surprise that TMG has been the standard-bearer for municipal borrowers in the international capital market. Aside from being the most vibrant economic hub in Japan, Tokyo is comfortably the largest issuer in the domestic market for local government bonds, accounting for about 15% of a market which in 2011 was worth $2.57tr. Although this compares with $2.99tr in the US and $1tr in Germany, making the Japanese local government market one of the largest and most liquid in the world, ownership of the market remains very insular. According to a presentation delivered on a roadshow last October by Japan’s Local Government Bond Association, as of March 2012, 42.6% of the market was held by domestic banks and 28.2% by insurance companies, with only 0.3% owned by overseas investors.
While a handful of municipal borrowers joined the association’s roadshow last year, bankers are doubtful that any will follow Tokyo’s initiative by issuing outside the domestic market, principally because their yen funding costs remain so low. “Most issuers’ funding requirements are not large enough to justify a major effort in international markets, given the administrative costs and hassle involved,” says Kodama. “Now that Met Tokyo is in the $1bn league, the bar has been raised even higher.”
Other Tokyo bankers are sceptical about the prospect for municipal borrowers issuing in international currencies. “My understanding is that the municipals have been roadshowing internationally mainly to market their yen bonds to overseas investors,” says one.
Others add that for overseas investors looking for exposure to the Japanese local government in yen format, JFM — rather than the individual municipals — is the most obvious issuer for them to buy. Aside from being highly liquid, with annual issuance of about ¥2tr ($21bn), JFM pays a small spread to the individual municipals, which is a reflection of its 10% BIS risk-weighting for unguaranteed issues. The local government issues are zero risk-weighted.