The Thai resort of Chiang Mai has become known among market practitioners as the place where Asean+3 finance ministers launched a network of currency swaps to cope with regional currency crises. Kyoto too may find its name inscribed on the monetary map of Asia by measures to boost the development of regional bond markets, which ministers are expected to announce when they meet this year in the Japanese city.
“Now the focus is more on Asian bond markets because, if Asian countries can develop domestic and regional bond markets, they can avoid a repeat of financial and currency crises,” Asian Development Bank president Haruhiko Kuroda tells Emerging Markets. “If long-term bond markets can be developed, then savings can be better intermediated into long-term investment.” With an estimated $3 trillion required for infrastructure development alone in Asia over the next 10 years, the need for such improved intermediation is a pressing one.
Now, local regulators, governments and international institutions are trying to speed liberalization and development of local bond markets – opening markets to foreign investors and allowing international borrowers to issue domestically.
There have long been wide discrepancies across the region in terms of economic development, capital market practices and financial infrastructure. Also, unlike the dollar or euro-denominated markets, the region lacks a single currency, and there has tended to be an over-dependency on the banking sector.
“Asian debt as an asset class is maturing,” says Foong Hock Meng, president of Pimco Asia. “The growing number of first-time issuers underscores the shift away from excessive dependence on bank borrowing.”
The amount of Asian currency-denominated bonds (excluding Japan) totalled only $400 million 10 years ago, but has grown to $2.8 trillion today. Even so, a recent study by McKinsey Global Institute found that Asia (ex Japan) accounts for just 3% of the total $44 trillion of domestic-currency bonds in issue throughout the world. The US accounts for 44% while 15 principal European countries account for a further 26% and Japan 20%.
Getting the framework in place is the first task. The ADB is pursuing its own initiatives to smooth the path for bonds to be issued throughout Asia by sovereign or other public issuers and by the corporate sector. Various other bodies, ranging from the Asian Pacific Economic Cooperation Forum (Apec) to the EMEAP group of regional central banks, are also pursuing bond market initiatives. But the prime focus in Kyoto will be on the finance ministers group.
Progress report
“The Asean+3 finance ministers meeting will issue a progress report, which will contain a lot of achievements,” Masato Miyachi, senior adviser in the ADB’s office for regional economic integration in Manila, tells Emerging Markets. Among the highlights are expected to be the establishment of an Asian bond clearing and settlement mechanism and of a regional credit guarantee organization to enhance the investor appeal of Asian bonds.“The next phase will be getting into securitization, and how to finance infrastructure [via bond markets],” he says. But first the infrastructure of bond markets themselves needs to be put into place. Hence the significance of the announcement to be made in Kyoto on the progress of six working groups set up several years ago by the Asean+3 group is of great significance, Miyachi adds.
ADB contribution
The ADB itself meanwhile continues to make ground-breaking ventures into Asian bond market development as part of its own fund-raising activities. Last year the Bank issued $10 billion-worth of Asian currency notes in various Asian jurisdictions, and “the remarkable thing” was that these all used the same documentation [using UK law] irrespective of where they were issued, says Miyachi.
“We have already made issues in Hong Kong and Singapore, and we are planning to do it in Thailand and also Malaysia. Since these use the same documentation, that contributes to the reduction of costs,” he says. So if I am a global investor, I can just buy. Before it was a lengthy process using different types of documentation and negotiation with the government concerned. Now it is a single format, and that is good for issuers and investors.”
Just as the ADB moved more than a decade ago into issuing bonds in various Asian currencies in order to spur market development and to provide a yield curve for other issuers, so the move to launch new kinds of issues such as the Asian currency notes is designed partly to ease the path for other public- and private-sector bond issuers in the future, he notes.
The biggest demand for bond market issuance is expected to come from the infrastructure sector in Asia. “There is a lot of infrastructure demand here in Asia, but because of the risks involved, a lot of it has not materialized,” says Miyachi. The ADB’s next project will probably be to “study how to finance infrastructure through bonds”, he says.
New arrivals
Local currency projects or revenue bonds are expected to make an appearance in Asia in answer to the demand for funds. The idea is that commercial banks will provide short-term, high-interest loans to cover construction of infrastructure facilities such as transport, communications and power, with the bank loans being replaced by a bond issuance once revenues flow from the project. Miyachi says he is confident there will be a “big demand” for these from institutional investors.
Asian bond market initiatives will be an “important component” in helping to close the infrastructure gap in Asia, deputy director-general of the ADB’s private-sector operations department S. Chander tells Emerging Markets. It will lead to greater “commercialization” of infrastructure projects in the region and “more diversification of the sources of finance”, he says. It will also lead to a “stabilization of bond markets across countries” in the region and ability to absorb risk.
“If you look at two industries which have a natural advantage in supporting infrastructure in Asia, it is insurance and pension funds, because they both have a long-term interest in preserving a pool of funds which have to be invested in reasonably low risk ventures,” says Chander.
“Infrastructure is long-maturity and low risk, and it provides a very steady and predictable source of income once construction is completed. Typically, sponsors have a loan to cover construction and then issue bonds, subscribed by insurance or pension funds. In the West, this is quite standard, and in Asia, it is catching on. You don’t have large commercial pension funds or insurance companies yet with that kind of appetite here, but it is coming.”
Cross-border integration
With increasing emphasis on regional integration in Asia, the need for cross-border infrastructure facilities is growing, and with it the need for new types of financing. Miyachi is convinced that bond market development has a role to play here too. For example, he says, “Currently there is a hydro-power project in Laos which sells electricity to Thailand. What they are looking at is to issue Thai baht bonds backed by hydro receivables.”
This is just one of a range of options which the ADB is examining. Another is the possibility of issuing multi-currency bonds. “We conducted a study into the European experience in this area,” Chiemi-Jamie Kaneko, a capital markets specialist at the ADB, tells Emerging Markets. “When the ecu [European currency unit] launched, smaller countries like Portugal benefited because they could tap into a composite of a basket currency and issue bonds in that currency,” she says.
Some argue that the ADB and others should focus on development of individual, domestic bond markets in Asia before looking at cross-border issuance, multi-currency bonds and other exotica. But Miyachi insists that “the two run in parallel.” One of the working groups set up under the Asean+3 is examining the need for such parallel development, he notes. Nomura and Daiwa Research Institutes in Japan have been appointed to conduct tailor-made bond market systems for Vietnam, the Philippines and Indonesia, he notes, even as regional initiatives continue.