Something unusual is afoot in the Asian US dollar debt market.
The accepted wisdom has been that ratings are an essential and important part of attracting international investors to Asia’s bond market. Ratings provide a recognised benchmark for investors of all types and suggest a willingness to be open and transparent.
But the statistics for US dollar debt in Asia Pacific ex Japan shows that another dynamic is at play. This year a record amount of borrowers have issued US dollar bonds without a rating. Nine percent of the US$117 billion raised in US dollar-denominated debt in Asia ex Japan this year is unrated, according to Dealogic data. This percentage was five in 2011 and 2010 on year-to-date figures of US$71.4 billion and US$80.5 billion respectively.
Unrated debt has always been a factor of the market but its size and breadth this year is unprecedented and set to grow.
It would be easy to dismiss this as just demand from private banks - which have become an investor force to be reckoned with this year – or just from a purely Asian investor base that knows these credits and is happy to buy them on name recognition alone. But the evidence points to the contrary. Institutional investors, both in Asia and abroad are now showing a stronger appetite for unrated debt. Some of this is self fulfilling, as unrated bonds have become a bigger part of the market, investors have felt need to allocate to these bonds so as not to underperform. That in turn encourages more borrowers to sell unrated bonds.
This could be viewed as wholly negative for the development of Asia’s bond market. Non-rated borrowers come in different types but they tend to be more at the high yield end of the credit spectrum and opt not to get a credit rating as they this would increase their funding costs. And the fact that so many investors are willing to invest in this debt because of the return its offers adds to arguments that Asia’s bond market is in the midst of a bubble.
Yet the argument can be made in favour of this development. Both private banks and institutional investors have the capacity to conduct their own in depth due diligence on credits before choosing to invest in bonds. Asset managers have told Asiamoney PLUS that even when a borrower is rated, they carry out their own research and come up with an independent assessment before investing. And as the failure of a recent bonds from Far East Consortium demonstrates investors are not willing to accept any credit at any price.
This development also offers the opportunity for the borrowers who might not otherwise be able to access the capital markets to start building a franchise. For example, India is home to strong companies often with an international footprint but the country’s rating of ‘BBB-‘ acts as a rating cap to these businesses and prevents them from accessing foreign funding.
The development of non-rated bonds as a distinct asset class would allow borrowers in India and elsewhere to diversify their funding sources and give investors access to a market that for a number of reasons, they are underweight in their portfolios. A lack of rating does not have to equal reckless behaviour. A market for unrated bonds means borrowers who may otherwise be put off from issuing offshore can start building a profile in the international debt markets. Investors will demand a certain amount of transparency and the only support the name if they come with the right price and credentials.
At a time when countries such as India, Indonesia and the Malaysia have huge infrastructure needs and are struggling to fund these purely in their domestic market, getting access to the liquidity provided by quantitative easing in Europe and the US is a positive solution.
And Asia’s US dollar debt market is in need of diversification. Excluding Australia and Japan, Chinese and Hong Kong and South Korea credits account for over 50% of the region’s G3 debt this year, according Dealogic data. There’s only so much exposure investors can take to Korean state-owned entities or Hong Kong and Chinese property companies, and only so much funding any one industry needs.
Coming to market without a rating is not the right strategy for every issuer. Multinational companies are unlike to benefit from issuing without a rating as investors do have expectations for companies of a certain size and reputation.
Dealers need to ensure they act in the best interest of the market when advising issuers. The continued success of Asian bond markets will depend on prudent pricing and retaining confidence.
This is not a phenomenon that will be limited to Asia. As the credit profiles of European sovereigns sink ever lower, dealers hint that corporate in that region are exploring their own opportunities for coming to market without a credit rating.
There is no reason why unrated debt should not develop as an asset class alongside investment grade and high yield bonds. Asia’s bonds need diversification and this is one solution that responds to the unique challenges of developing its debt capital markets.