Basel III to boost to US dollar bonds in Asia
The eurozone’s ongoing debt problems and the deleveraging by region’s banks as they seek to meet capital requirements under the Basel III framework will benefit US dollar bond issuance in Asia, say experts.
Strategist, global investment solutions
UBS Global Asset Management
Essentially the answer is yes on both counts, but don’t expect a smooth ride. A key requirement of Basel III is that the amount of capital banks must hold is calculated on a risk-weighted basis. That makes it more appealing for banks to invest in less risky bonds.
Following the financial upheavals of recent years, not least in the eurozone, a large number of Asian issuers now find that their debt is considered less risky than that of many issuers in developed markets – a novel departure. This comes against the backdrop of a structural underweight in bond investors’ exposure to emerging markets.
Such debt accounts for some 15% of global sovereign debt outstanding but a weighting of just 6% in ‘real money’ bond investors’ portfolios, according to the International Monetary Fund’s latest Global Financial Stability Report.
This is bigger than the corresponding structural underweight in emerging-market equities. We would not be surprised if long-term inflows to Asian debt as an asset class are met with higher issuance volumes in response.
But this asset class remains vulnerable to bouts of volatility induced by big outflows or inflows over the short-term, which tend to be highly correlated with investors’ risk appetite globally.
Last year, for example, emerging-market debt saw higher outflow volumes than high-yield corporate debt – another asset class to which investors are turning in the search for yield amid low interest rates. Moreover, liquidity levels can be low in some Asian debt markets, particularly in ‘risk-off’ environments – imagine a crowd of investors all rushing for a narrow exit.
So while there are certainly interesting opportunities in Asian bond markets, both issuers and investors need to be patient and to time their entrances and exits judiciously.
Head of Asia fixed income research and head of global corporate credit strategy
Our analysis of the impact on Asia from European bank deleveraging suggests a manageable but challenging process of replacing wholesale funding provided by European banks and absorbing assets previously held by these banks. While it’s unlikely under orderly scenarios to create major challenges to Asian credit conditions, it would dry up a source of wholesale foreign currency funding for banks and impede their ability to offer foreign currency loans to clients – both of which point to more supply from both financials and corporates ahead.
For financials, a sharp reduction in foreign currency wholesale funding would be critical and replacing it would create upside risk to bond supply for most of Asia ex-Japan, where we are already seeing pressure from high foreign currency loan growth.
Specifically, we see an increased risk of foreign currency bond supply from banks in Singapore, Hong Kong, Korea, India, Malaysia, Thailand and China (particularly if Chinese banks decide to increase their market share as a result of European Union deleveraging).
For non-financial corporates, European bank deleveraging also creates supply risk. We estimate that continental European banks provide US$264 billion funding to Asian corporates. This could be replaced either by Asian banks, through corporate deleveraging or through capital markets.
As our analysis suggests, where the European exit impact is meaningful on both bank and corporate funding, the supply risk increases fast. In our view, that creates significant issuance potential for corporate Hong Kong and corporate India.
There are several implications for the markets. Firstly supply will likely increase in 2012, perhaps to record levels. Secondly, the proportion of first-time issuers should be high as banking relationships may need to be replaced by capital market relationships.
Lastly, the new issue premium may be stickier going forward as the funding flexibility previously offered by banks is diminished.
Credit analyst, fixed income
The combination of higher economic growth rates for the region, Basel III and European banks steadily downsizing their exposure to the region, will almost certainly be a boon to Asian US dollar bond issuance.
On the corporate side, the funding would be geared towards financing expansions, refinancing maturing debt and replacing the financing void created by European banks. As for banks, Basel III would effectively push these financial institutions to term out their funding maturity profiles and enhance their net stable funding ratios.
As a result, banks would favour direct investment in corporations and support bond issuance over direct lending. This is because loans with maturities of over one year would require 100% stable funding coverage while corporate bonds with maturities over one year would require as little as 20% coverage.
Given that US$60 billion-US$65 billion worth of US dollar denominated bonds were issued in 2010 and 2011, respectively, it is likely that Asian issuance will top these figures in 2012. In January alone US$10 billion dollars of US dollar denominated bonds have been issued. We also anticipate a change in the composition and sectors where issuance is likely to be heavier.
We expect a large portion of issuance from corporations and banks in particular from countries including China, Hong Kong and Korea to dominate.
The high yield space in comparison would be much quieter for new issues in 2012. Higher yields, particularly from Chinese high yield corporations due to poor earnings outlook, weaker credit profiles and concerns over corporate governance is likely to keep a lot of issuers out of the markets.