Hong Kong and Singapore's local currency bond markets are often hailed as the models to which the rest of Asia's fledgling domestic capital markets should aspire. The region's two largest markets do offer efficient funding alternatives for certain issuers and volumes are growing across the board, but a mismatch between the demands of investors and borrowers is holding back further development. Steve Garton reports.
The local currency bond markets in Hong Kong and Singapore have much in common, with high short term liquidity and regulations that support cost-effective MTN programmes, and their development is providing steady business for the region's investment banks. Progress into true alternative markets capable of absorbing every size and tenor, however, is slow.
Hong Kong boasts Asia's largest and most mature local currency bond market, and new issuance is showing strong year-on-year growth. The total volume of new issues reached HK$187.3bn ($24.1bn) in 2005, up about 10% from the 2004 figure and topping the previous record for new issuance that was reached in 2000, according to Brian Yiu, chairman of the Hong Kong Capital Markets Association.
But the positive performance betrays a lack of depth in the market. Most of this new issuance was sold by financial institutions, and the heavy reliance on short term bank deals has led some observers to label Hong Kong as little more than a "money market".
"The Hong Kong dollar market is highly effective for high grade issuers looking for cost-effective short term funding," says Sean Wallace, head of capital markets at JP Morgan in Hong Kong. "However there is no sub-investment grade market and the number of issuers able to go beyond five years is very limited."
The range of foreign issuers, similarly, is dominated by financial institutions which are attracted by the efficient pricing they can achieve on short term issues, while supranationals and a handful of the world's largest companies have also been able to issue in Hong Kong dollars.
Bankers point to several factors to explain this lack of depth. The investor base may be growing, but appetite for long tenors and corporate issuers remains limited, while domestic issuers often see Hong Kong's competitive syndicated loan market as their first port of call.
"The natural long term investors in Hong Kong have historically tended to be dollar users — such as insurance companies with policies and liabilities in US dollars — with little interest in local currency bonds, and this created a mismatch," says Brad Levitt, group head of capital markets at Standard Chartered in Singapore. "Things are changing, with more natural HK$ investors emerging outside of the banks, and more issuers are becoming interested in long term deals as a result."
Hong Kong's Mandatory Provident Fund, started at the end of 2000 to manage the pension scheme, has grown to a total of HK$165bn in assets under management by the end of March 2006. As the scheme grows it will add liquidity to the local capital market, but the amount invested in the bond market remains small. Only HK$1.9bn is held in MPF-approved funds that invest exclusively in bonds, according to CEIC Data.
"There is some investor demand for more deals from corporate issuers," says Olivier Destandu, head of EMTN, structured products and local currency at Deutsche Bank in Singapore. "The problem is that not many Hong Kong companies need cash, and a bond issue would be expensive for them relative to the funding they can obtain in the bank market."
Investors in Hong Kong also tend to hold paper until its maturity, limiting the size of the secondary market. Opinion is divided as to the effect this has on primary issuance.
"Hong Kong is really a buy-and-hold market, and the lack of market-makers is a problem," says Destandu. "There are probably only four or five banks that are active in the secondary market as market-makers, and there is a risk that investors will be deterred by the lack of price transparency."
Frank Kwong, head of syndicate for Asia at BNP Paribas in Hong Kong, says that secondary volumes have been growing, and that other benchmarks are available. "Most issuers are already known in the derivatives market, so there is a CDS curve that is regularly used as a benchmark for bonds that are issued under an MTN programme."
Another feature of the Hong Kong market is the intense competition for mandates, which has led to a number of issues being underwritten by arranging banks without a book-building process. This tactic is employed by banks that look to garner additional revenue from the sale of swaps or other instruments, but has been criticised for stunting market growth by distorting pricing.
"The problem in Hong Kong is that there is so much liquidity," says John Pitfield, head of local currency syndicate at Citigroup in Singapore. "The market will develop very slowly if investors have to compete with arrangers for paper due to the huge amount of bank liquidity, and the dedicated Hong Kong dollar bond assets under management remain relatively limited."
Kwong at BNP Paribas argues that arrangers follow similar tactics in every market. "Subsidies play a part in transactions in every market, and Hong Kong is no different. There is no reason why this should hamper development."
Indeed, Kwong says that the long end of the curve is becoming more popular with issuers: "The Hong Kong syndicated loan market can meet the short term funding needs of domestic issuers very efficiently, but we find that many of the same borrowers are looking to the bond market for 10 year finance," he says. "There has been a huge pick-up in 10 year plus issuance in the last couple of years, with almost every supranational issuer tapping that part of the curve," he says. "This has become possible as life insurers have been increasingly looking at long end bonds."
Chasing higher yields
The Hong Kong dollar market is tailored to very high quality issuers, thanks in part to asset managers that are very averse to credit risk — investors with greater risk appetites look to the equities market. While Hong Kong's investors play into the hands of banks and supranationals, foreign corporate issuers are finding that Singapore can provide some useful diversification.
"The Singapore dollar market is more yield-conscious with investors that will take credit risk if the spreads are attractive," says Kwong. "As a result, financial institutions play a smaller role in the Singapore market than they do in Hong Kong."
Emirates, the Middle Eastern airline, is set to test the appetite of Singapore dollar investors for corporate credits with a S$300m-S$400m five to 10 year deal via Citigroup, DBS and Standard Chartered. Emirates will be looking to repeat the success of Cathay Pacific, the Hong Kong-based airline, which successfully raised S$225m in 3.0575% five year funds in February 2005, choosing Singapore over its own local market.
Bankers have praised the measures taken by the Singapore government to attract foreign issuers such as Cathay and Emirates, but here again the market suffers from a disparity between issuer demands and investor appetite.
"With the shape of the curve in Singapore, there is no incentive for investors to buy on long tenors," says Destandu at Deutsche Bank. "This creates a mismatch between what borrowers want and what investors are prepared to pay for. If more issuers were interested in one year or two year deals then we could do much more in Singapore, but we need to develop a longer market."
Levitt at Standard Chartered is more positive. "Singapore has a more natural investor base for long term paper, and the government has brought out a number of initiatives in an effort to diversify the market," he says, listing insurance companies among the investors potentially interested in long-term bonds.
The Monetary Authority of Singapore is committed to developing the domestic bond market, recently unveiling an electronic platform designed to improve pricing transparency on government bonds. "One of the lessons that emerged from the (Asia) crisis was that we need to develop a bond market to act as a viable alternative source of financing for corporates," said Ong Chong Tee, deputy managing director of the MAS, at the launch ceremony in May. "Being a small country, to develop the market further we need to globalise the Singapore bond market by attracting more international players to issue and to invest in Singapore."
Since 1998 the government has grown to be the largest issuer in the Singapore dollar market as it looks to stimulate issuance and create a benchmark. The volume of outstanding government bonds stood at S$57.5bn as of March 2006, according to CEIC, with tenors going out to 10 and 15 years.
"Only the Singapore government has so far tapped the long end of the Singapore dollar market, as pricing is not so attractive and other issuers have not been convinced to pay a premium to diversify their funding," says Joel Consing, managing director and head of financing solutions for Asia Pacific at HSBC in Hong Kong. "Educating the investor base is key to developing this end of the market."
But bankers have noted a growing resistance from Singaporean investors for bonds with maturities of over 10 years. "Singapore dollar issuance this year has shifted away from the long term as investors have become more cautious due primarily to the continued increase in short term interest rates," says Standard Chartered's Levitt. "There is still some interest in 10 year rated paper but many of the issuers that are looking at this market are unrated and will find it more challenging, with even the usual longer term investors looking at shorter term paper due to interest rate volatility."
Sean Wallace at JP Morgan says that the slowdown in long term deals can be explained by a lack of supply, rather than demand. "Corporate issuers may be taking a view on interest rate movements or have decided that they don't need the money, but there is no lack of appetite from investors," he says.
Whether because of investor interest or issuer needs, Singapore suffers from the same dearth of opportunities at the long end of the curve as Hong Kong, and bankers can see no quick fix ahead. The two markets are streets ahead of the rest of Asia, but are young in relative terms — the first international deal in Singapore dollars was only in 1998, with a S$300m offering from the International Finance Corporation, the World Bank's private sector arm, and progress has been gradual.
Says Pitfield at Citigroup: "There is no shortage of issuers in Singapore, but investors are focused on shorter tenors due to the flat yield curve and interest rate uncertainty. Singapore though has successfully attracted investors with tax breaks and other incentives. The right moves are being taken to help develop and promote the Singapore bond market, but remember it took 40 years or so for the Euromarket to become what is it today."
While both Singapore and Hong Kong are celebrated in Asia as examples of where the region's other emerging local currency markets should be, the two offer distinctly different models. Singapore's interventionist policy, for instance, contrasts sharply with Hong Kong's laissez-faire approach, but both markets have shown encouraging development particularly in short term issuance. The path towards the same breadth and depth as the international markets may be slow, but Asia's largest local currency markets are still worthy role models for the rest of the region.