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Derivatives

Asia prepares for life after QE

The last few years have been a gift to Asian local currency markets as issuers and investors turned to the region while G3 markets struggled to find their feet. But with the US Federal Reserve indicating its willingness to reduce its bond buying programme when it can, the region has to prepare for what life will look like without quantitative easing, writes Lorraine Cushnie.

Asia local currency bond markets have boomed in the years since the region’s financial crisis in 1997 and been one of the main beneficiaries of the collapse of Lehman Brothers and the subsequent credit crunch.  

This was no accident. The events of 1997 forced the countries of the region to focus more attention on developing their own bond markets, meaning they were better positioned to cope with the fall-out from 2008. Much of this work was driven by the Asian Development Bank under the auspices of its Asean+3 Bond Market Forum (ABMF).  

Working with the 10 countries that make up the Association of South East Asian Nations (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam), as well as China, Korea and Japan (the +3), the ABMF is trying to standardise market practices and harmonise rules across the region to make it easier to issue bonds. 

“During the Asian financial crisis the big issue was a currency mismatch: firms borrowed in foreign currency, their domestic currencies depreciated and many of these companies went bust,” says Thiam Hee Ng, senior economist in the ADB’s Office of Regional Economic Integration. “One of the ways we looked to solve this issue was to promote the use of local currency bonds and the idea of greater inter-regional issuance.” 

Local currency DCM volume for Asia ex-Japan stood at $224.7bn in 2008, up from $137.6bn the previous year. Since then it has risen consistently, apart from a dip in 2010, according to Dealogic. Volumes hit a high of $714.6bn in 2012, compared to the $110.7bn worth of issuance in 2005 (see graph).

Because Asia’s local currency markets remained open for business during the credit crunch, this made them much more attractive to outside borrowers, not to mention investors taking part in the well documented hunt for yield that drove so much capital into the region.

Dim sum in demand

One of the biggest success stories in Asian local currencies has been the offshore renminbi (CNH) or dim sum bond market. As part of China’s efforts to internalise its currency, it was launched in 2010. Bond volumes grew to almost $14bn in 2012 and are set to see further growth this year. It has also been successful in attracting inter-regional borrowers and those from outside Asia, as well as Chinese credits. Borrowers include Caterpillar, Ford and Renault. 

Raising currency to fund onshore operations is one of the primary reasons multinational companies (MNCs) issue dim sum bonds. “What drives international issuers is if they have business or investments in China, then it makes sense to issue in renminbi in order to match their exposure,” Ivan Chung, senior credit officer at Moody’s. “If MNCs try to borrow in China they may find difficulties. Highly rated MNCs, which in most other countries could get a lower cost of funds, won’t be able to in China because the banks feel much more comfortable lending to state-owned enterprises.” 

Using the proceeds onshore was the reason BSH Bosch und Siemens Hausgeräte wanted to launch a dim sum bond, according to Andreas Stolzenburg, director and department head corporate finance and M&A at the company. 

“We’ve completed two issues in renminbi and this was based on the fact that we do have a substantial and growing onshore business with a significant cashflow in renminbi,” he says. “Consequently, we saw this as a good opportunity to finance our onshore subsidiary.”

BSH raised a combined Rmb3.25bn ($529m) across two multi tranche deals in September 2011 and July 2012. The bonds were preceded by roadshows in Hong Kong and Singapore to select money managers and banks and it took six months from BSH first considering the bond to printing the first deal. 

The other driver is arbitrage, which can require careful monitoring of a market which remains prone to liquidity squeezes. This was certainly the case for the International Bank for Reconstruction and Development, part of the World Bank group and which made its debut in January 2011 with a Rmb500m two year bond. 

“Issuers have to be ready to issue or monitor the market,” says James Fielder, head of local currency syndicate, Asia, at HSBC, which led the deal. “For the World Bank we were monitoring the CNH market for a year, once we got to within the range of where they were happy to price we were able to pull the trigger very quickly.” 

But while offshore renminbi grabs most of the headlines, other markets have also managed to attract foreign issuers. Thailand is one example, despite all the hurdles it forces issuers to jump through, and has attracted a growing number of non-Thai names. Korean borrowers including Export-Import Bank of Korea and Korea Development have been particularly active in the market, coming in when the after-swap costs look attractive. Thailand was also home to the first international bond issue from Laos (see box). 

Singapore has also emerged as one of the region’s most liquid and developed local currency markets, with borrowers from around Asia targeting it for long dated funding and corporate hybrids such as Malaysian casino operator Genting’s S$1.8bn ($1.4bn) perpetual from March 2012. Malaysia, meanwhile, is now the world’s biggest sukuk market, with a growing roster of issuers from the Middle East and across Asia.  

Credit risk differences

Non-domestic issuers do not have it all their own way when it comes to local currency bonds. Much has been done to develop and deepen Asia’s bond markets, but they remain relatively illiquid due to a lack of diversity in the investor base, and with limitations on what size and maturities borrowers are able to achieve, especially if the proceeds need to be swapped.  

The average deal size of Thai baht bonds from foreign borrowers was Bt3.7bn ($116m) in 2012, while for offshore renminbi the same figure for non-Chinese issuers was Rmb640m ($105m).

Domestic investors can also view credit risk very differently, much to the disadvantage of international borrowers. “In most cases investors want a pick-up to the local name otherwise they would rather buy the local credit, and that’s frustrating for the double-A or triple-A rated names because they don’t get the benefits of that rating,” says HSBC’s Fielder. “In baht, for example, you need to offer 30bp or 60bp or more over Thai govvies otherwise local investors won’t buy, so the key is to find the credits that fit in the middle.”

With a few exceptions, such as supranationals and Korean policy banks, many borrowers are yet to become regular issuers of Asian currency bonds. 

“A reason why we may not see repeat issuers is that issuers use local currency deals for a specific funding exercise,” says Henrik Raber, global head of debt capital markets at Standard Chartered. “For example, when a foreign company issues in CNH, that deal could fulfil the company’s requirement for a number of years.

“Deals in some local currencies are done on standalone documentation, and not all local markets operate with the typical EMTN programme. Thereby, doing domestic documentation can take longer time.”

Going global

For their part, Asian countries have not simply been waiting for investors and borrowers to come to them. Increasing investor interest in the region over the last few years, combined with improving credit profiles has led to the emergence of bonds denominated in local currency but sold globally. Most notable are the Philippines’ global peso bonds from 2011 and 2012 (see profile on page 24) and Thailand’s amortiser from December and inflation linker from March. 

However while these bonds have had a good reception from investors, they are yet to be followed by other sovereigns in the region such as Indonesia, Malaysia or Singapore. One reason could be the fairly high barrier to entry. 

“A sovereign needs to come along and do something different to justify using a bank syndicate — for example, Thailand did an amortising bond and an inflation linker,” says HSBC’s Fielder. “Investors want to know that the sovereign will be a frequent issuer, the last thing they want to do is set up global fund and find out the supply dries up.

And while these bonds may have a role to play in raising the international profile of countries such as the Philippines, the ADB’s Ng is less convinced that they do much to develop local currency markets. 

“Global bonds are a second best option, they make it easier for investors, but it doesn’t encourage those investors go into the local markets. The key is to make it easier for investors to access the local currency markets,” he says.

Surinder Kapthalia, managing director, Asean, at Standard & Poor’s, takes a more optimistic view. “Global issues of local currency sovereign bonds can be a teaser to that market,” he says. “Once global investors have an appreciation for that market they will start to look at corporate issuers in that country’s local bond market. Such issues can also help countries manage their FX exposure.” 

But if the last five years has been a triumph, the next five could be much trickier. Asia’s local currency markets have borne the brunt of investors’ changing approach to risk ever since Federal Reserve chairman Ben Bernanke suggested in May that quantitative easing could start to be withdrawn. 

There have been a number of repercussions. Investors that had over-allocated to emerging markets are now moving to a neutral or underweight position, which in Asia has caused bond spreads to widen and currencies to depreciate — in some cases severely. This means that arbitrage opportunities are now few and far between for borrowers that need to swap the proceeds, as well as generating a negative perception among investors. 

The internationalisation of local currency markets has also taken a hit. Until September, there had not been a single non-Chinese issuer in the dim sum market since June, while Malaysia, Singapore and Thailand’s bond markets have become noticeably more domestic in their make-up during this period. 

This preference for hard currency is expected to continue for the time being, although Jon Pratt, head of DCM, Asia at Barclays believes the CNH and Singapore dollar markets will still be attractive. 

“The Singapore market is one that holds up in times of stress and the other positive is that it provides access to long dated funding for a broad range of credits,” he says. “For many companies, it’s a good alternative to the US dollar high yield market. Through our discussions with clients, we are aware of a wide range of companies in southeast Asia with equity market visibility but have never issued public debt. They are now considering the SGD market for their debut debt deals.” 

Meanwhile, offshore renminbi retains its position as a market of strategic importance as the currency continues to internationalise. And while there is a realisation that Asia’s local currency markets may lose some of their international flavour over the next few months, the consensus is that they are in stronger position than ever before and will be ready as soon as international borrowers decide to return.

“On the one hand you have more opportunistic issuers which look at markets from the point of view of whether they will be able to get cheaper funding,” says Andrew Stephen, head of private placements and local currency issuance, Asia at Deutsche Bank.

“On the other hand, you have people on the asset liability management side who will have to come to market anyway because they have a need to fund in these currencies. It’s the opportunistic side that is more susceptible to a slowdown in difficult markets.” 

   Perseverance pays off for Laos   
  For all the rhetoric about interregional bond issuance, the examples of Asian borrowers that have issued in local currencies are few and far between. One notable exception is the Lao People’s Democratic Republic, which in May this year made its international bond market debut with an offering in Thai baht. It is set to follow that up with a second issue later this year.

The process certainly was not a quick one.  Supported by the ADB’s Asean+3 Bond Market Forum (ABMF), Laos first floated the idea of issuing a bond in one of Asia’s local markets in 2003. Thailand was an obvious choice, says an official at the Laos external debt management division in the Ministry of Finance. 

“Since 2003 we have been making the case for Laos to issue bonds and we were looking at Thailand because of its proximity to Laos and the strong trading relationship,” says the official. “But at that time the Thailand Ministry of Finance had restrictions only allowing rated issuers.”

It took nine years, but in December 2012 Thailand changed the rules to allow sovereign issuers to sell bonds without a rating. Laos’ Bt1.5bn ($47m) three year bond followed in May 2013, paying a 4.5% coupon and coming in 2.7 times oversubscribed. It was offered at 175bp premium to underlying Thai sovereign bonds, which are rated BBB+. 

Thailand’s TMB Bank was the sole lead manager and Laos firm Twin Pine Consulting came on as adviser. The deal made Laos the first sovereign to issue in Thailand’s domestic market and the first non-rated issuer. 

“It was difficult to base the pricing on Laos bonds because of course they are denominated in kip, so we looked at where other issuers in the market were pricing, including the Thai government,” says the official. “Laos also used to borrow term loans from Thailand so we looked at those as well. I told TMB the range in which I was happy to price in and we were able to come to the market.” 

Thai investors already had some familiarity with Laos, but the country decided to go on a roadshow. Eventual buyers of the bonds included the Stock Exchange of Thailand as well as high net worth individuals, banks and funds, according to the official. 

Thailand was a natural first choice for Laos, but it did consider some of Asia’s other local markets — although was deterred by the pricing. 

“We did do some work looking at markets such as Malaysia and Singapore, but if we had had to issue in Singapore, the yield we would have had to pay would had been higher than the yield we paid in Thailand,” says the official. “After the swap we got a level of 3.9% for our Thai baht bond. We definitely want to go into other markets but the main priority for us is the price.”

Laos is now looking to establish a curve in Thai baht. In September it received approval from the Thai MoF to sell a second bond for up to Bt3bn and is considering a five or seven year deal. It hopes to act as an example to other unrated sovereigns in Asia and to develop its own domestic bond markets. 

“Our bond is not much if you look at the size compared to other issues in the market,” he says. “But it’s not about financing, it’s about development — finding out where the yield curve is so we can set an example to other countries like Myanmar and Cambodia.”

 
     


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