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Asian ECM painful for Western banks, but sophistication grows

Asian equity capital markets are maturing, slowly but surely. Institutional investment is growing and capital pools are getting deeper. However, change cannot come quickly enough for ECM bankers in the region, who hope that an improving 2017 will make up for a miserable 2016. Adrian Murdoch reports.

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A residual nervousness remains in equity capital markets in Asia. For bankers, 2016 was a grim year, which started badly and then got worse. It was characterised by job losses and declining fees.

The nadir came last October, when Goldman Sachs and Bank of America Merrill Lynch made huge job cuts in reaction to declining advisory fees and increased competition from local banks.

By the end of the year, UBS slashed almost two dozen jobs in Hong Kong and Singapore and the banking community was almost too punch drunk to react.

The business simply is not there. Fees from Asia Pacific equity and equity-related deals plunged by almost a quarter in 2016. Last year’s $207bn of equity offerings was the lowest figure since $159bn in 2013.

Heading towards the end of the first half of this year, the pipeline for 2017 looks considerably better than at any time for the past few years — and this despite the uncertainties surrounding the delivery of US president Donald Trump’s much promised economic renaissance.

In Hong Kong, for example, there are some big deals coming down the slipway from financial heavyweights: an up-to $1bn IPO from Guangzhou Rural Commercial Bank; a similar amount from Zhongyuan Bank and around $700m from Bank of Gansu.

There is a similar enthusiasm from the financial and property sectors in mainland China. Certainly any companies thinking of floating were given a boost at the end of last year after Chinese regulators relaxed the sometimes arduous approval process for IPOs, in a move to keep a lid on corporate debt.

But before bankers allow themselves to relax, the promised dealflow may not be enough to wipe away the memories of the past few years.

In January, many bankers were excited at the prospect of a mouth-watering A$2bn ($1.5bn) flotation from Australian gas and electricity utility Alinta Energy, but the deal was pulled at the last minute as it went for a trade sale instead. Elsewhere, the A$1bn IPO of Origin Energy, touted to be Australia’s largest this year, still remains only that — likely this year (in the third quarter, say optimistic bankers).

Catalyst-oriented markets

But while IPO flow has been disappointing, the markets continue to evolve, with inflows to funds and a growing sophistication of investors.

“The equity capital markets have become increasingly global and interconnected. They are being more than ever driven by macro and political events and are generally more catalyst-oriented,” says the head of Asia Pacific ECM syndicate at one bank in Hong Kong. “Technology has been a large factor in the transparency of public companies, as well as the faster pace in which investors can get up to speed and invest in markets.”

Certainly the outlook for investors is positive. Equity investors, particularly when looking at equity capital markets deals, are increasingly exchange-agnostic and much more focused on names. They want stocks which have clarity in reporting, are led by high quality management, are well covered by research and exhibit good liquidity and trading profiles.

Institutional investors in the region, along with hedge funds, have substantially increased assets under management, contributing to the large increase in equity market capitalisation in the region — both for Asia’s emerging and developed markets.

This pool of capital will grow in importance, rather than decline.

ECM will be an important area for investors. Sellers want to monetise their stakes in companies via IPOs. “At the same time this will give investors the opportunity to participate in liquidity events to increase their share ownership in the corporates that they would like to own,” says the banker.

All good news for companies trying to raise money, but none of it sounds good for the banks. A modest number of fee-generating larger floats is likely to hit the bottom lines of arrangers yet again, all the more so as competition has increased across the region from the growth of domestic banks, especially in China.

Korea shines

It all looks quite gloomy, but there are two bright spots. The first is Korea. The W2.65tr ($2.3bn) listing of Netmarble Games in April was clearly one of the early deals of the year — the largest IPO in the country since 2010 and the second biggest ever in Korea. It is significant because the deal was priced against a background of political turmoil, as the former president was being charged with corruption.

The region’s other shining light is India. “Valuations remain quite rich but they continue to attract flows on the back of a stable macro/currency and optimism around earnings recovery on the back of reforms,” says Subhrajit Roy, head of ECM origination at Kotak Mahindra Capital in Mumbai. Even though final volumes were way off the expected $15bn, last year India had its best year for IPOs since 2010 with around $4bn.

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This year looks like it will be a record, despite prime minister Narendra Modi’s demonetisation. Indeed, many on the Street believe that this could help, by channelling savings to the financial sector. Certainly there is no doubting the performance of the Sensex. Over the past 12 months it has shown a return of 20.6%, according to Bloomberg.

That means there has been an understandable rush for private equity investors to exit their investments via IPOs, on the presumption of high valuations. “We expect to see a continued surge in FII [foreign institutional investor]/DII [domestic institutional investor] inflows,” says Roy, adding that by the end of May, volumes were double those of last year. Domestically, for example, mutual funds have seen how successful an IPO exit has been for private equity players and now, swollen by retail investors, are keen to grab a piece of the action too. 

Of those, the FII figures are the ones to keep an eye on. Over the past decade the FII ownership of Indian stocks has jumped from 19.3% to 24.2%, according to Kotak Mahindra Capital, but what is more interesting is what is happening under the hood.

The holdings of passive funds have substantially increased and passive flows have become a market driver, as all investors become more comfortable with the market. Certainly part of this is a growing maturity for Indian equities.

“Investors, both domestic and foreign, are increasingly focusing on corporate governance,” says Roy, pointing out that there has been an emergence of proxy firms — independent opinion and research on corporate governance issues — and there is a growing sense of shareholder activism. “Though still at initial stages, it is increasingly becoming evident,” he says.

That is very much the key to the shift in the equity markets. There are still those in the market who see equities as cyclical. With bonds having been top dog over the past few years, it is time for equities to shine again, they argue.

But investors and markets are cannier than that, and have become increasingly choosy about the names they pick. Good news for the market, in the long term — but valuations need to reflect that.

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