ASEAN Bond Markets Investor Roundtable: Investors mull changes in the rating environment
Global and domestic investors taking a close look at the ASEAN bond markets have to face a number of issues, including how best to hedge unwanted rate risk, how to navigate a choppy swap market, and how to ensure that they get the best value from issuers that often have plenty of financing options elsewhere. But when Asiamoney gathered an esteemed panel of investors and market experts at its latest ASEAN Bond Markets event in Kuala Lumpur, only one topic dominated discussion: ratings. We took the opportunity to get the view from market participants inside and outside the country on just how important ratings are, how big the unrated market can get, and how end-investors can be convinced to trust funds' own credit work.
Chu Kok Wei, group head, treasury & markets, CIMB
Christian de Guzman, senior analyst, sovereign risk group, Moody's Investors Services
Goh Wee Peng, chief investment officer - fixed income, AmInvestment Management
Khoo Boo Hock, vice president, operations, Credit Guarantee and Investment Facility (CGIF)
Adam McCabe, head of Asian fixed income, Aberdeen Asset Management Asia
Nor Masliza Sulaiman, head of capital markets, CIMB
Wong Loke Chin, head of fixed income - regional, CIMB Principal Asset Management
Dr Yeah Kim Leng, dean of business school, Malaysia University of Science and Technology (MUST)
Moderator: Matthew Thomas, contributing editor, Asiamoney
Asiamoney (AM): Malaysia is an interesting case in the credit rating world since Moody's, Standard & Poor's and Fitch all have different views on the future direction of ratings. What is driving this discrepancy?
Christian de Guzman, Moody's: It is a source of some consternation in the market how much variety there is in terms of the outlook for Malaysia's rating, but that‘s what makes a market work. We have a positive outlook for our A3 rating, one of competitors has a stable outlook and the other has a negative outlook. It is probably the only country in the world where there is that much difference in the outlook. It should go without saying that we are not all the same: we have different methodologies, and we tend to emphasise different aspects of a particular country’s credit profile.
We are inherently comparing Malaysia to other countries, not just to how it was a few years ago. But having said that, we put the country on a positive outlook in 2013, and 2014 was a relatively good year. We saw GDP growth accelerate, the current account surplus widen, and fiscal consolidation gain traction. We saw fiscal reforms accelerating. In a sense, we have already been proven right in terms of our outlook. In 2015, the fall in the oil price is obviously damaging for the economy, but how many people could have predicted that?
The major focus for us is fiscal consolidation. There has been major progress in this area: for those who have been watching Malaysia for a long time, or indeed for those who live here, it is obvious that the removal of fuel subsidies was a pretty historic decision. We are looking to see how the government responds to external challenges. The oil price is clearly one of those major challenges, but there are others such as the imminent normalisation of US monetary policy. There are political challenges. The depreciation of the ringgit has impacted sentiment on the ground. There is also a widespread acceptance that growth will be slower this year. But Malaysia will continue to grow faster than other A-rated economies, despite these risks.
AM: One of the things that comes up a lot when people talk about ASEAN bond markets is the need for an ASEAN rating agency. Christian, I would imagine that you would argue that a pan-ASEAN rating agency is not really needed, since we already have global ratings agencies such as Moody's. But at the same time, there are a lot of companies that have not ventured outside of their domestic markets and as a result have not got global ratings. Do you think global rating agencies need to work more closely with smaller rating agencies in different markets?
De Guzman, Moody's: We do have certain arrangements allowing us to cooperate with rating agencies in different markets. We completed our acquisition of an Indian ratings agency last year. We have also previously invested in an Indonesian rating agency. But generally speaking, the need to provide a local perspective is very important. We do provide some local flavour already. We are continuously on the ground to visit issuers and to get the lay of the land, and we have people with years of experience working in markets across the region. These are some ways that global ratings can overcome the challenges of not maintaining an actual physical presence onshore.
Dr Yeah Kim Leng, MUST: The domestic rating agencies in this region have gotten together and created a forum to try to harmonise ratings across the region. It remains to be seen how successful that will be.
There have been a lot of studies on mis-ratings, showing that there is some developed market bias. These are not studies by the smaller agencies; they are written by academics. There are quite a number of issues relating to the rating agencies. We need to move to much more of a cardinal approach to ratings, rather than the ordinal approach we have at the moment. The approach at the moment means that downgrades of one country are likely to impact those of others, as well as those of corporations. There needs to be a new way of doing things.
There are some interesting studies showing that the information and predictive value of ratings have declined, but rating agencies' market power has increased at the same time. There is a disconnect somewhere. Many investors have ratings guidelines hard-wired into their investment decisions. We need to move away from this as much as possible and, of course, rating agencies need to work to improve their approach.
AM: We are very used to looking at the ratings of a country or a corporation and seeing everything summed up with a few letters. One country is rated double-A; another is single-A. Is there a better way of understanding credit quality?
Dr Yeah, MUST: There are a lot of advanced techniques used in the research area to judge the credit quality of a country, but the rating agencies have apparently not caught up with these advances. This is why we see a very large unexplained portion when we feed ratings into our models. This is partly to be expected, of course. There is a degree of opinion to all of this.
It is more important, however, to reduce the dependence of the market on ratings than it is to reform the rating approach of the various agencies. Investors are so dependent on ratings at the moment that downgrades can have a massive impact.
AM: Boo Hock, you talked in the previous panel about the headache of getting ratings from five different agencies. It is natural that agencies should have a range of opinions but, in your experience, how different was the process that these agencies actually undertook to come to their view?
Khoo Boo Hock, CGIF: It has been quite varied in terms of engagement. But fundamentally, the biggest challenge for us is that the rating methodologies used to rate us are very different, which can be quite tricky to handle. Their views of the underlying guaranteed obligors' credit strength in our portfolio can be materially different, too. There is also a clear difference between international scale and national scales.
For example, we guaranteed a bond from Masan Consumer Holdings last year that was denominated in Vietnamese Dong (VND). Depending on perspectives, one may conclude that that this consumer goods giant's ability to repay their VND obligations is superior as it is one of the stellar corporate entities in Vietnam. As such, we are guaranteeing a very low risk obligation. But from an international scale perspective, the corporate's credit quality has to be constrained by the fact that it is based in and operates only in Vietnam; a country that has an international scale sovereign rating that is not yet investment grade. To those running risk and capital models, these differences of rating opinions, perspectives and methodologies mean that the default rate assumptions can vary wildly, from less than 1% to over 10%.
To be cautious, we adopt a conservative approach for now. That might be to our detriment sometimes, but our job over time is to prove that the risk for local currency bonds may be lower, notwithstanding the low sovereign ratings accorded to many countries in the region we cover. How corporate ratings are influenced by sovereign ratings really needs more detailed analysis. Simply adopting the capping or anchoring approach is a convenient assumption, and people often use convenient assumptions because of a lack of alternatives. Because rating agencies all use the same rating scale for all asset classes including sovereigns, corporates, banks, insurance, asset backed securities, and so on, it is also convenient to assume that they are all directly comparable. But looking at the default rate tables published, this is certainly not the case.
AM: It would be interesting to get a view from the investors on the panel on this point. How do you navigate the diversity of ratings opinions — and how important are ratings to your end investors?
Adam McCabe, Aberdeen Asset Management: Investors give money to us to invest on their behalf. They are very much conditioned by their past experiences. It is no surprise that they want a lot of the mandates hardwired to look at a combination of ratings from two or three of the major rating agencies. For us to overcome the difference in standards and start to use more local market ratings, there are an awful lot of changes that need to take place. A lot of institutions will need to rewrite their investment mandates. I don't think there is any chance of that happening anytime soon. There’s just very little bandwidth for that to happen on the demand-side right now.
There has been a lag between the style of investments and the wording of investment guidelines. There has been a lot more money moving into Asia, including local currency bond markets, over the last few years. But nothing has changed in terms of the rating requirements. That makes it very difficult when it comes to dealing with a local investment in Indonesia, for instance. Do we need to continue to rely on the big three, or can we use ratings from one of the local agencies? And if we do use a local rating, how can we rank the different agencies in each local market?
There has been a push by regulators around the world to ensure that managers do not solely rely on a third-party rating. Managers have to do the credit work themselves. That is going to be the best way to solve the ratings issue. We will still also want to use the insights of others, but it is fundamental that we show our clients that we can do a lot of the work ourselves.
We saw three or four years ago that many funds relied on the third-party model, but more and more they are building their own in-house research teams. At Aberdeen, we have a very large team and we have long had a bias to do the in-house work ourselves. But the competition for talent on the research side is definitely heating up. That is symptomatic of the increasing focus on building in-house research teams.
Goh Wee Peng, AmInvestment Management: Ratings are very important for many of our institutional clients. Malaysian clients, in particular, are quite conservative. They tend to not want us to invest in anything rated less than single-A, or in some cases even double-A in case there are any downgrades. Some investors seem to forget that investment grade is actually triple-B; we don't see much demand for triple-B deals in this market.
There was an interesting case recently. The Abu Dhabi National Energy Company (TAQA) decided to remove its rating from RAM, because it wanted to cut costs. That created quite a panic among local investors. But they are still rated by S&P and Moody's, which have given them ratings of A-/A3, on par with Malayisa. The local rating assigned by RAM was AA1. This brought confusion to investors in Malaysia. Should they price TAQA at triple-A, because it is the same rating as the sovereign? Or should they continue to price TAQA as a AA1 credit?
It is interesting for us to ponder how we can map back from international ratings to local ratings. A lot of mandates here are based only on MARC and RAM, but when the international agencies rate a deal, there should be an easy way for investors to become comfortable.
Wong Loke Chin, CIMB Principal Asset Management: All of our clients are very ratings-focused. Most of our mandates require us to invest in single-A or above and, as Wee Peng said, some even want us to focus on double-A or above.
Most of the bonds in our portfolio are rated locally. The global issuers tend to have at least two ratings. But in Malaysia, there is usually only one rating given to individual issuers. It would probably be wise to move towards most local issuers having two ratings at this point because it will reduce ratings shopping among issuers.
De Guzman, Moody’s: The value added by our ratings has always been the qualitative aspect of it. It is indeed relatively simple for anybody to put together a spreadsheet and spit out a rating. But it is our on-the-ground knowledge, experience, and our relationships with issuers and governments that bring value to the market. The qualitative aspect of our ratings — although seemingly subjective — is important for investors to understand. But at the same time, it is the key area where we try to demonstrate our value.
We don't particularly like ratings to be a required aspect of issuance. We would welcome a lot more competition, but we also recognise that there is a market for unrated deals too. This is where it becomes particularly important for investors to do their own credit work.
AM: Malaysia is transitioning to a point where within two years all unrated bonds will become freely-tradeable. It seems from the discussion already that there is a pretty rigid ratings focus from end-investors in Malaysia. Given that fact, how difficult is it going to be to ensure liquidity for these unrated bonds and, as a result, encourage unrated issuance to really grow?
Chu Kok Wei, CIMB: The major investors for unrated bonds at the moment are predominantly banks, as well as some corporate loan investors. The tradeability of unrated bonds will certainly increase the opportunities for funds in this market, but whether their end investors allow them to start buying unrated bonds remains to be seen. Fund investors often impose a rating requirement here, but for banks it comes down almost entirely to the internal credit approval model. Funds are likely to move closer to the situation at banks at the moment.
Nor Masliza Sulaiman, CIMB: In the past two years, between 8.3% and 9.5% of all the Malaysian ringgit bonds issued were unrated. You can see an increasing trend towards unrated bonds and this trend is expected to gain momentum when unrated bonds become fully tradable in 2017. Currently, there is a premium priced in the unrated bond deals given that it is non-tradable and non-transferable and therefore appeals to a limited investor base. Although banks still dominate the unrated bond market, we have seen increased participation from other investors, typically those with deep pockets and those who do not require active trading on their portfolios.
Investors should not look at ratings as the sole basis for their investment decisions although they can be complementary to help provide investors with an independent view on the credit.
McCabe, Aberdeen: There is one consideration here. Those who currently hold the unrated bonds may be waiting for the day to come that they can start trading them, and then perhaps there will be some massive selling pressure in the market, as those holders wish to clean up their portfolios. The initial period might not be as smooth as one would like. But if you think pragmatically about it, for those investors who can buy these bonds there is going to a big opportunity because of the inefficiencies in the unrated market.
There is a chance that this move could actually encourage more issuers to get credit ratings. Because of the way mandates are focused on single-A credits and above here, at present, there is no incentive for issuers to get a triple-B rating. But when trading in the unrated market becomes more significant, some issuers will see the logic in getting a triple-B rating because it is likely to improve their pricing. Either way you look at it, this is a positive development.
Wong Loke Chin, CIMB Principal Asset Management: We have a team of credit analysts that can look at unrated bonds. But we need to consider: will information be forthcoming to all investors, including those who are not already invested in a bond yet? Wee Peng mentioned the TAQA decision before. We held some of those bonds after they made the decision to drop the rating. But after the RAM rating was removed, we asked the trustee for information on the company and the first question they asked us was: are you a bond holder? It is important that there is still information that is freely-available to those who do not hold the bonds now, but who may consider buying them in the future.
Pension funds and insurance companies may have the balance sheets to start buying unrated bonds in large size, but asset managers will be limited. We still need to get the clients to agree to go into unrated bonds, and that process is going to take a lot of time.
Goh, AmInvestment Management: It is important we educate our clients on the opportunities in the unrated market. We need to show that we can do a lot of the work inhouse and that our own valuations are worthwhile and can be used not just alongside credit ratings but, in some cases, in the place of credit ratings.
A major reason why asset managers did not invest in unrated bonds before was that these deals were not tradeable. We stand the risk of investors pulling out their money and us not being able to sell our holdings. That is going to change, and that greater flexibility is going to be a boon for asset managers.
The big corporations do not want to pay ratings fees. These household names are likely to be the first issuers to sell unrated bonds in any significant size and because they are so well known, they are likely to get strong demand. It is a good situation for investors, because some of the money that these issuers save by not paying their ratings fees can be returned to investors.
Dr Yeah, MUST: The bond market is too segmented at the moment. There have been many efforts to increase awareness of lower-rated credits. They have largely been unsuccessful. But this announcement could have a major impact. It is certainly a good step for the market.
AM: Barclays has announced that it will add Malaysian shariah-compliant government bonds to its Global Aggregate Index on March 31, only days after this event. How much impact is this likely to have on demand for government bonds?
Chu, CIMB: It is definitely a positive step. It is part of this increasing global acceptance of sukuk, which you can also see from a lot of countries deciding to issue sukuk in the international market. It is only natural that as sukuk supply increases, indices need to be updated to reflect that. The market has come a long way in that regard.
Particular credit must go to the government of Malaysia, which has persisted issuing sukuk for so many years despite the fact that the spreads can be 25bp higher than their conventional bonds. That is not rational for a normal issuer, but the government knows there are bigger issues at play here. This is fundamental in ensuring that the sukuk market here has developed strongly.
McCabe, Aberdeen: We are very happy to build our sukuk exposure in our portfolios. Malaysia is certainly leading the charge, as Chu rightly said. That is why it really helps funds like us to have a footprint in Malaysia. It helps us to participate in the growth of this market, and benefit from decisions on the ground as soon as they happen.
There is a sense, though, that you should be careful what you wish for. Many foreign investors will now be able to invest in government sukuk here, but these investors are often transitory. When something goes bump in the night, they can leave the market very quickly and, as a result, they can significantly increase volatility. We caution a lot of investors around the world in relying too much on indices because they are sitting alongside so many other investors that are there for exactly the same reason. There is a big risk to that sort of crowded market participation.
Wong Loke Chin, CIMB Principal Asset Management: A lot of investors will not be happy with the move because they have long enjoyed the yield pick-up compared to the MGS market. That spread differential is definitely going to tighten a lot, and we have already seen that start to happen. There is no spread difference at all in the short-end of the curve, and the spread in the 10 year part of the curve has tightened from 25bp to 20bp since the announcement. We expect spreads to continue to tighten further and further.