Thriving investor base changes game but is yet to go green
Asian investors’ rise to dominance has caused a repricing across the region’s capital markets, and raised questions about just where US and European deals should price. How much further can regional liquidity rise in importance? GlobalCapital Asia finds out.
Participants in the roundtable were:
Ricardo Adrogué, head of emerging markets debt, Barings
Lorna Greene, director, origination and debt syndication, Asia, National Australia Bank
Yoshihiro Inoue, executive director, international debt origination, debt capital market, Daiwa Securities
Arthur Lau, co-head of emerging markets fixed income and head of Asia ex-Japan fixed income, PineBridge Investments
Kiyoshi Nishimura, chief executive officer, Credit Guarantee and Investment Facility
Amit Sheopuri, managing director, co-head of Asia debt origination, Citi
Rashmi Kumar, moderator, GlobalCapital Asia
Ricardo Adrogué, Barings: One of the benefits for Asia is that the capacity to lend is higher than in other regions in the world. The impact of the rising rates environment is also less in Asia than other regions, which is a big positive. One issue is however the high leverage in the Chinese economy, which has been talked about a lot in recent years. But as China has started deleveraging, the risks have diminished.
Arthur Lau, PineBridge Investments: Benefiting from healthy global growth and rising domestic consumption, we expect the current steady growth momentum in the Asia region to continue in 2018. Against this backdrop, we believe the Asian debt capital market will continue to grow as corporates and banks look for medium-to-long term sources of capital funding to support the business demand and opportunities. A constructive economic environment also bodes well for credit products. At the moment, we expect the Asian G3 bond market to reach $1tr market capitalisation by the end of this year or early next year.
Although it is low at the moment, there is rising concern about inflation in the region. In addition, many Asian central banks have also shifted their monetary policy rhetoric to a slightly tightening bias, which may pose medium term risk to the credit market.
Lorna Greene, National Australia Bank: The strong growth in investable funds here in the Asian region has been the key driver of tighter pricing outcomes for dollar-denominated transactions which accommodate Asian investor participation. This has been evidenced in the strong growth in order books for 144A/Reg S issuances open in the Asian time zone, where the Asian investor bid has accounted for up to $2bn-plus and where the strength of the regional appetite for dollar assets has allowed for a tightening of price guidance at the start of the New York session.
However, this dynamic has been most clearly shown by the strong growth of the dollar Reg S market, which saw close to 75% growth year-on-year in 2017 and with projected further growth of about 20% plus year-on-year for the next three years. The market has gone from being a source of supplemental funding for many global borrowers to being an important source of funds in its own right.
In addition to the new larger volumes and tighter pricing outcomes achievable in the dollar Reg S market, the flexibility that issuance in this market offers has also been a factor in its attractiveness to debut borrowers. From the lower minimum benchmark size requirements, to the greater willingness to look at a broader range of credits/sectors and consider issuance with lighter covenants, accommodative conditions have been driving an increase in debut deals. China has historically accounted for the lion’s share of the market. However, 2017 saw a significant increase in issuance from a wider group of countries including Japan, India, Indonesia and Australia, which offer investors greater opportunities to diversify their credit investments. Australian corporate borrowers in particular have been recognising the benefits of issuing in the dollar Reg S market, with seven debut issues from the jurisdiction seen in 2017 and with a steady pipeline of new issuance expected over the course of 2018.
This increased bid out of Asia is certainly here to stay. The rising liquidity in the region is being driven by a number of macro factors, including the ongoing shift in wealth from West to East and the growing middle class in the region, as historically emerging market countries enjoy strong growth and continue to develop at speed. That said, the current demand for dollar-denominated assets is certainly being bolstered by the decreased attractiveness of some domestic investments, as countries such as Taiwan and South Korea cut rates in 2017, as well as by the increasing dollar rate hike trajectory. Current demand levels could reduce if this dynamic were to reverse. But investors in the region are holding the biggest pool of dollars outside of the US, so we would expect demand would always be robust for dollar assets.
Adrogué, Barings: There has been an impressive growth in the Asian investor base, which has provided a great source of savings for companies. This means a lot of corporations don’t need to go to the US market to raise money anymore. In terms of pricing advantage for issuers, you’ll see that spreads over US Treasuries quoted out of Asia offer you much less spread than other parts of the world.
We have seen an improvement in the quality and diversity of issuers coming to the market, with an increasing number of non-banking financing corporates coming to the market too, primarily from Asia. An increasing number of corporates don’t go to the US and Europe — they price their deals during Asia hours and market during Asia hours, despite which we have seen some non-Asian investors participate.
Lau, PineBridge: We have seen a significant change of market dynamic in the Asian markets due to a more diversified investor base, from the region and also globally. Asian credit has shorter duration and higher yields than the more traditional fixed income markets in the US and Europe. As such, the Asian credit market’s high-risk adjusted return has appealed to many medium to long-term investors globally. The strong demand for Asian bonds has caused the so-called Asian risk premium to compress noticeably in recent years.
Moreover, strong local bids from institutional investors, such as pension funds, insurance companies and asset managers, also provides strong support to the market. Given the local knowledge and proximity to the market, the regional investors are able to support a deal that focuses on the region rather than the international market. This is evident by the surge in securities issued in the format of Reg S, which do not appeal to global investors. We expect this trend to continue as growth and wealth in the Asian region continue to be strong.
While investors are still participating in yen bonds sold by European banks, they are turning their focus to Asian credits as the yield is relatively more attractive in comparison. For instance, the Republic of Indonesia has established its status as a regular sovereign Samurai bond issuer starting from 2009, when it came out with a JBIC guaranteed structure. We expect more names from Asia and Greater China to come to the Japanese market using Samurai bonds, Tokyo Pro-Bonds and private placements. But Japanese yen is not the only thing investors are looking for. They are also increasingly keen on non-Japanese yen investments, such as alternative currency products like Australian dollars and US dollars, in their pursuit of absolute yield enhancement in their portfolios.
In addition, Japanese investors are less active in the secondary bonds market as the majority of them prefer to hold to maturity. They are also less flexible with the timing of their investments. Typically, they are required to go through a lengthy process to make investment decisions and add new credits to their portfolios. Some also need to have physical meetings with issuers before their final decisions. We have seen an increasing number of Asian issuers visiting Japan to have face-to-face meetings with investors, to strengthen efforts in making their names familiar to Japanese investors.
Compared to the Asian buy-side, Japanese investors are more flexible about purchasing less liquid paper, such as through private placements. This enables issuers to have flexibility in selecting the tenor, issue amount and timing. By developing long-term relationships with Japanese investors, Asian issuers will be able to create a new funding source in the Japan market.
Greene, NAB: We have already started to see a shift in the types of bond investments that the Japanese investor base is looking at. A wider variety of investors, across a broader range of sectors — including local insurance companies — are considering credits lower down the credit curve within the IG space and are looking at a broader range of geographies than before, with an increasing focus on issuance from regional IG-rated borrowers from jurisdictions including India and Indonesia. This increased focus on a broader range of credits is certainly positive for the market, adding to the depth of the investor base for these credits and allowing Japanese investors to further diversify their bond holdings.
Greene, NAB: There are a number of advantages for issuers in continuing to approach the European and US investor bases for funding. Investor diversification is one of the key benefits, allowing issuers to source a broader range of funding, and ensuring borrowers always have access to funding, be it in G3 or other niche currency markets. The broader demand also allows for stronger order books providing momentum to the transaction and allowing for better pricing outcomes. Different sector preferences, or levels of familiarity and understanding of particular sectors among different regional investor bases, can also allow for more successful transactions when strategically targeted towards the most appropriate region.
Adrogué, Barings: The dominance of Asian investors will continue based on the current trends. Savings in Asia are still high, and if you look at the data, Asian investors are doing well. But bonds from unrated issuers are not bought much by non-Asian investors, and these borrowers also don’t go out to US or European accounts. It’s somewhat short-sighted as having access to a diverse pool of investors is important if one market is closed due to turbulence.
But the experiences of investors in Asia are different to those in other parts of the world. US and European investors have been exposed to situations of defaults and so are more wary of taking on unrated credits. It explains why some Chinese investors and regional investors are more comfortable with Asian unrated credits.
Lau, PineBridge: I don’t think there is conclusive evidence. After all, unrated bonds still represent a smaller number of issuances in this region. It is more of a niche market at the moment.
Lau, PineBridge: It is encouraging to see international agencies given the go-ahead to be allowed to rate onshore bonds, although it is still a work in progress. Since the rating approaches between international and China’s onshore rating agencies have fundamental differences, I think the presence of international rating agencies in the onshore market will have a profound impact on both the ratings dynamic and credit spreads. Nevertheless, it remains to be seen whether international rating agencies’ onshore ratings gain the same credentials as they have done in the international market and whether they could be insulated from local influence.
Greene, NAB: The very strong support from the Chinese investor base for domestic names that they understand well and feel comfortable with has indeed led to some pricing dislocation when it comes to issuance, most notably from the Chinese banking sector in comparison to similarly rated global peers. Given this strong support and the vast exposure that many Chinese investors now have to these names, we have seen the demand normalise to an extent, particularly as more names debut in the market. This is giving investors an opportunity to further diversify their holdings, which is something that is also being encouraged by Chinese regulators.
Greene, NAB: Dollar-denominated issuance from US and European credits continues to be attractive to Asian investors, particularly as secondary market supply of these credits is limited, therefore boosting demand for these borrowers in primary. To take advantage of this demand, issuers are starting to recognise the benefits of opening 144A/Reg S order books in the Asian time zone, allowing regional investors the opportunity to participate. This is a practise that Australian bank borrowers have adopted in recent years, which has resulted in significantly larger order books and tighter pricing outcomes as a result of the strong momentum this increased demand brings to the deal. However, there are still many US and European borrowers who are not yet taking this approach, but that have targeted issuance in the Australian dollar and Formosa bond markets as a way to access the strong Asian demand.
The appetite of regional investors for Australian dollar issuance has increased over the course of the last few years, adding significant additional depth to the Australian dollar market, resulting in increased issuance from both European and US-based financial institutions and corporate borrowers. Average deal sizes achievable have increased and Australian dollar credit spreads have continued to grind tighter off the back of the increased demand.
Likewise, the Formosa bond market has allowed these borrowers to access regional pools of dollar liquidity without having to open order books for 144A/Reg S publicly offered deals in the Asian time zone. Last year saw borrowers such as Apple tap both of these markets to meet local investor appetite for their credit and raise cost effective funding.
Kiyoshi Nishimura, Credit Guarantee and Investment Facility: The development of green bond markets in North America and Europe has been done in a bottom-up manner or has been market driven, led by growing demands from responsible investors or green investors. In contrast, the green bond market in China, which has become one of the largest in the world in the last two or three years, has been developed in a top-down manner, or by the government’s policies and regulations, despite the absence of a strong green investor base in the country. We believe we will see similar development patterns of green bond markets in other Asian countries.
An encouraging sign is that other Asian countries have already started to follow suit, setting policies and regulations to develop their green bond markets. This is significant because a lack of clear policies or regulations has been a major factor that has been hindering development of green bond markets in other Asian countries.
At the regional level, one notable recent development is the introduction of the Asean Green Bond Standards by Asean countries in November 2017. Asean’s regional standards, which are based on ICMA’s Green Bond Principles, can become the base for more detailed frameworks or guidelines at the national level, and have already spurred the issuance of green bonds in Asean bond markets based on the Asean standards.
At the national level, Singapore is especially keen to promote green bonds and introduced a grant scheme in June 2017 for that purpose. We believe the government’s push has led to the issuance of a number of green bonds in Singapore last year even though the grant scheme was not directly relevant to these cases.
Malaysia also has its own regulatory framework to promote green bonds. The Sustainable and Responsible Investment sukuk framework covers green sukuk as its major component and a number of green sukuk have already been issued under this framework. As part of its efforts to create a dedicated investor base for green and sustainable bonds, the Securities Commission of Malaysia also introduced new guidelines for SRI dedicated funds in December 2017 and is encouraging large institutional funds to allocate a certain percentage of their investment assets to SRI bonds.
We believe that these policy efforts at both regional and nation levels will lead to the growth of green bonds in Asia. Once the supply of green bonds increases, this will, in turn, help create a dedicated investor base for green bonds in Asia.
Nishimura, CGIF: Like Singapore or Malaysia, some Asian countries have already introduced a grant scheme or tax incentives to promote green bonds. In addition, governments can consider using state-owed entities to issue green bonds in their domestic bond markets to increase the supply of green bonds there. They can also encourage public funds such as national pension plans or sovereign wealth funds to invest in green bonds to create core green bond investor groups in their debt markets.
While it is necessary to weigh in compliance costs, the introduction of mandatory reporting on companies on their ESG activities such as energy use, carbon emissions, water use and waste generation, will encourage companies to focus more on activities with positive environmental and social impacts, encouraging them to issue green bonds. Such reporting requirements also reduce incremental costs for potential issuers of green bonds by making it easier for them to comply with the reporting requirements of bonds. In this connection, it is worth noting that many securities exchanges in Asia — including Malaysia, Singapore, Thailand and Vietnam — already require ESG reporting as part of their listing rules, and the enhancement of such ESG reporting rules can indirectly encourage more companies to consider issuing green bonds.
Promoting green bonds in the Asean local currency bond markets is one of CGIF’s priority areas. We have already supported Asean local currency bonds issued to finance projects with positive environment benefits, including a note issued by AP Renewables’ Tiwi MakBan geothermal plant complexes in the Philippines and also one issued by KNM Group, a Malaysian company, for its bio-fuel project in Thailand. AP Renewables’ bond was the first certified Climate Bond issued in an Asean country and the first green bond issued in the Philippines. We are also working on a number of potential green transactions including the first roof-top securitization in the Asean region.
Some issuers have been reluctant to consider green bond issuance to date due to the additional work and cost involved in establishing the required green bond framework, with many borrowers looking for a pricing advantage as a result. Although demand for the product is increasing, this has not yet translated to tighter pricing outcomes versus regular senior unsecured issuance. While initiatives like MAS’s Green Bond Fund in Singapore, which helps reduce barriers to issuance by subsidising some of the associated costs, could certainly help encourage more borrowers to consider green bond issuance, stronger investor demand will be the key driver for more issuers to consider issuing in this format.
Adrogué, Barings: As an investor, I would say the key ingredient to buying an SRI bond is having the institutional infrastructure in place that gives you confidence that a bond you are buying is a green or a socially responsible investment. Institutions that are selling such deals need to be credible about where the proceeds are finally going to.
Inoue, Daiwa: Japan is Asia’s pioneer country in SRI bonds, starting with the IFFIm [International Finance Facility for Immunisation] vaccine bond in 2008 targeting Japanese retail investors. The uniqueness of Japanese SRI bonds is that the market’s development started from retail investors backed by high savings and deposits ratio as well as a high awareness of environmental and social issues, and then penetrated into institutional investors in recent years. The retail-targeted SRI bonds mainly focused on general investors’ interests, and familiar social issues related to life and poverty reduction in developing countries. These general interests accommodated not only green bonds, but also a variety of SRI thematic bonds such as water bonds, EYE [Education, Youth and Employment] bonds and woman bonds.
In recent years, Japanese institutional investors, mainly lifers, have become active in SRI Bonds, disclosing their investments in the form of both public offerings and private placements. Also, the introduction of Japan’s Green Bond Guidelines in March 2017 by the Ministry of Environment has been crucial to strengthening the recognition of SRI Bonds, including green bonds, in Japan’s capital markets. With the principle kept the same as the Green Bond Principles by ICMA, the guidelines have made green bond standards clearer for Japanese investors.
Thanks to the increased recognition of SRI bonds in Japan, we believe the country’s capital market could provide one of the best places in Asia for other Asian countries to start or test SRI bond offerings. They will certainly be backed by keen demand from both Japan’s institutional and retail investors.
Nishimura, CGIF: We are particularly interested in the growth of solar project bonds in Japan. In view of Asean’s large investment needs in renewable energy and proliferation of solar projects in many ASEAN countries, we believe the format developed in Japan to finance solar projects by project bonds can be replicated in Asean countries too.
Greene, NAB: Investor demand for green/SRI issuance has been slower to grow here in the Asian region in comparison to peers in Europe or the US. Typically, demand for this kind of product and a change in cultural focus to favour SRI investment is very much driven by local and regional governments setting the tone. Japan has been a leader in the region, with the government having introduced a number of initiatives to encourage investors to focus on the importance of SRI investments, which has already resulted in a number of the largest local insurers and fund managers setting aside a significant portion of funds under management for SRI investments.
Other countries such as Singapore have also put initiatives in place to boost the regional green bond market. Back in 2016, MAS established the Green Bond Fund, targeted at encouraging more issuers to issue in this format. However, as long as there is no price advantage, investors continue to lack motivation to focus specifically on investing in green/SRI bonds over regular senior unsecured issuance. One positive aspect of green bond issues that is favoured by many investors however is the detailed and ongoing annual reporting that is required. The added transparency that this provides makes green bonds attractive to some investors.
If more governments across the region focus on working together with investors to encourage their participation, we could see a shift in investment culture that would further boost demand for green bonds and SRI investments more broadly.
Lau, PineBridge: I am not sure I can agree about little real progress in this area. For instance, China has CIBM and Bond Connect programmes, in addition to RQFII and QFII, to facilitate overseas investors to go onshore. These are big developments. Index providers, such as Citi, have also included China onshore bonds in some of their indices. Take Indian bonds as another example – the restrictions such as the investment quota have also relaxed markedly to allow foreign participation.
One may argue that hedging tools and the depth of the market for hedging may still need improvement.
According to data compiled by AMRO [Asean+3 Macroeconomic Research Office], while domestic bank loans were still the dominant sources of funding for corporates in these countries with the amount of $13.4tr as of September 2015, domestic bonds ranked second at $2.8tr, significantly surpassing cross-border loans ($0.7tr) or international bonds ($0.2tr). This shows that local currency bond markets in the region have already come a long way from their negligible status before the Asian financial crisis in the late 90s to become the main funding sources for corporates in the region. This is thanks to concerted efforts of governments in the region, such as Asian Bond Markets Initiative, to develop local currency bond markets.
Despite this remarkable development, local currency bond markets in the region still face many challenges. One of the biggest challenges is that, while the aggregate size has grown, they consist of fragmented national bond markets at different developmental stages and of relatively small sizes with different regulations and market practices. Due to a lack of standardisation and harmonisation, intra-regional bond investments are still limited. This hampers efficient mobilisation of the region’s vast savings towards the region’s vast investment needs. Instead the region’s excess savings are still invested mainly in financial markets of developed countries.
In order to promote cross-border issuance and investment flows for better mobilisation of savings, the governments of Asean+3 countries have been working together towards the standardisation of bond issuance practices and harmonisation of regulations. One core initiative under this collaboration is the creation of the Asean+3 Multi-Currency Bond Issuance Framework (AMBIF). AMBIF will allow companies to use standard documentation, which is called single submission form, to issue bonds in professional bond markets in AMBIF member countries.
While it was introduced in 2014, there has been only one AMBIF pilot issue, in September 2015 in Thailand, and actual progress has been rather slow. However, as more companies in the region pursue regional expansion and are involved in cross-border investments, there is growing interest in AMBIF among corporates as a new funding platform to support their regional business activities. Hong Kong/China, Japan, Malaysia, Philippines, Singapore and Thailand have joined AMBIF and other countries are also considering joining.
CGIF is already working on a number of AMBIF transactions including those targeting new AMBIF member countries to prepare their participation in AMBIF. If these transactions are successful, this can trigger more interest in AMBIF and can be a game changer to accelerate integration of local currency bond markets in the region.
Adrogué, Barings: What is more important is how diversified the local currency investor base is. When you broaden out your investor base to include investors from the whole world, it is more difficult to envision a crisis scenario taking place.
Nishimura, CGIF: While it is true that foreign participation in financial markets may become a channel for risk transmission, and further tightening of global liquidity conditions in the coming years may exacerbate this concern, we should not forget the benefits of foreign participation.
Most of the Asian bond markets still lack depth and liquidity, the main cause of which is still a narrow base of domestic bond investors who tend to adopt a buy-and-hold investment strategy and tend to have homogeneous investment profiles. Increasing participation of foreign investors with different investment strategies and diversified investment profiles in local currency bond markets can improve market liquidity, and hence enhance efficiency and lower financing costs for companies.
Generally speaking, we believe current conditions are very different from the time of the Asian financial crisis in 1997-98, the experiences of the global financial crisis in 2008-2009 and the taper tantrum in 2013. They have proved the capacity of Asian countries to weather these crises relatively well. Some empirical researches suggest the growth of local currency bonds since the Asian financial crisis has reduced the vulnerability of financial markets of these countries as local currency bond markets act as a ‘spare tire’ to enhance resilience in the event of shocks. Given this, we believe that benefits of foreign participation still outweigh risks caused by foreign participation.
In addition, while it is true that some Asian countries like Malaysia and Indonesia already have very high foreign investors’ holding of local currency government bonds, if you look at local currency corporate bonds, foreign holding is still very negligible in Asia. It is clear there is more scope to encourage foreign participation in local currency corporate bonds to improve liquidity and depth of these markets.
Furthermore, the composition of foreign investors can be an important issue. Domestic investors can play an anchor role to stabilise the market when external shocks hit the country. When the domestic investor base is not strong, regional foreign investors with a strong understanding of the country and the market can play a supplementary role to domestic investors, unlike non-regional foreign investors whose investment decisions can be more influenced by external factors.
We believe the same phenomenon is also happening in the dollar bond markets where regional investors are bringing more stability to the market. This is the reason we believe further regional financial integration is important to enhance the resilience of financial markets against external shocks.