Asia’s bond market has lost the rulebook

Volatility in Asian dollar bonds has put the focus on marketing tactics deployed by banks, and in particular some Chinese securities houses, to win over investors — tactics that are distorting price discovery and putting pressure on the secondary market. Are standards falling in the region? Rashmi Kumar finds out.

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Bond bankers in Asia are worried. Not only about the market turbu­lence that is slowing down their underwriting business, but also about market practices that have emerged as a result of this rough patch.

Some in the industry are not mincing words.

“The bond market has changed dramati­cally for the worse,” a head of debt capital markets at the investment banking arm of a Chinese bank told GlobalRMB in late June.

The distress stems from the practice of some banks to offer rebates to institutional investors to woo them into transactions from Chinese borrowers. This discount is different to the rebate offered to private banks, which has been an accepted part of the Asian bond market for many years as long as it is disclosed in the offering document. In contrast, a discount to insti­tutional investors goes against the idea of selling the notes at a fixed reoffer price to investors until the bonds can be freely traded in the aftermarket.

DCM heads at international and Chi­nese investment banks point their fingers at Chinese securities houses, which are understood to be the chief culprits in the practice. One Greater China DCM head at an international bank also reckons one or two Wall Street firms have taken to offering rebates to long-only funds.

One consequence of this is that bond pricing in the primary market has become distorted as some buy-side accounts have an advantage over others.

Shorter term, the impact is that second­ary market performance of many dollar notes has been abysmal. In the long run, the situation is causing DCM bankers, investors and issuers to increasingly lose their faith in the debt market.

“The practice of offering a rebate is just horrible,” says a head of DCM for Greater China. “We have had some large investors come to us and say: ‘if XYZ bank is on the deal, we refuse to place an order as we don’t know what the actual pricing of the bond should be’. Price discovery is becom­ing pointless and skewed and the true yield of a bond is not what is publically shown if say 60% of the investors in the deal have a rebate.

“Some investors have also gone to issuers and said ‘if you use this bank or secu­rities house for your bond, then we refuse to participate in the deal’,” he adds.

A few bankers reckon the questionable practice has gone mainstream since the end of last year, with one banker saying it may have been used under the radar as far back as two years ago. Yet another says it largely hit the team’s screens only in the past two months. While opinions differ on the timeline, what is clear is that standards slipped when the market turned competitive, but that amid a bull market environment, the practises went largely unnoticed.

ON SHOW

Discount rates have ranged from 30bp to 40bp, with some accounts demanding as much as 1% of the deal’s face value, say bankers. The impact of this tactic has been clearly reflected in the aftermarket performance of many dollar bonds sold by Chinese issuers. In some cases, bonds have dropped by 50 cents to a point in the sec­ondary market immediately after pricing. In other cases, bonds have continuously underperformed since pricing day.

A DCM syndicate banker at the invest­ment banking arm of the Chinese bank says: “If the bond was sold at par to the public and if I were an investor that got it 25% cheaper, I will flip the bonds on the first day, in which case I can still get out of the deal without losing any money. But the next bid will be lower than that, and the bid after that lower still, which has ultimately destroyed the market. It’s a vicious cycle.”

Two investors at international asset managers contacted by GlobalRMB in late June say they have stayed well away from suspicious transactions as they are more long-term investors rather than punters looking for short-term gains.

It is hard to pinpoint which transactions offered a rebate and which did not recently, given that broader weakness in the fixed income market in the past few months has also contributed to bonds’ underper­formance.

The DCM syndicate banker admits it’s tricky to prove which bonds were sold on the back of sweetheart deals between the syndicators and investors. Finding out would require a thorough audit of all the deals, the investor orders and the prices offered to each and every account. Anecdo­tally, however, bankers reckon a number of high yield Chinese bonds sold by property developers were suspect, given their after­market performance.

Between January and end-June, 160 dollar bonds had been issued by Chinese companies, worth a collective $87.65bn, shows Dealogic. Of that, close to 60 trades totalling around $18bn came from property developers — nearly 50 of which were rated high yield or were unrated.

As of July 6, of the total Chinese dollar bonds, a large number of them were trading under water in the secondary market, which bankers say is due to a combination of a weak market backdrop and shoddy market practices.

The question now is whether the market can wean itself away from these bad habits, or whether the damage is irreversible.

THE BLAME GAME

“Some issuers know what’s going on but don’t care and just want to do a deal,” says a head of high yield at an international house. “These are the new issuers who are desperate for funding and don’t care about the secondary market performance, because if they don’t get the deal done, then there is no secondary market for them.

“But the sophisticated issuers care,” he adds. “They don’t want to hurt the second­ary performance of their notes especially if they will come back again in a couple of weeks.”

As for the banks, the head of high yield reckons some firms — again referencing some Chinese securities houses — are desperate to do deals to inflate their league table credits, especially if the bread and butter of their business is debt focused.

“The other thing is that many of the practitioners are rather green,” he adds. “I’ve been in the industry for 20-plus years, whereas some of the local houses only blossomed in the last two years and don’t have the same level of infrastructure and compliance. There were mistakes made by us too in previous cycles, but we have things in place now to ensure nothing goes wrong.”

Another senior banker pointed out that due diligence standards are not the only concern anymore — different standards used by international banks versus secu­rities for deal execution are also worrying, be it around the reoffer price or consistent book messages. While some rules are up for interpretation, some very aggressive interpretations are being taken by firms.

And then there are the investors. The Greater China DCM head says he has had requests from some accounts for a rebate. The investors often demand the discount by citing a similar deal they have been offered by another bank.

“As a responsible officer, I simply cannot sign off on that,” he says. “We have had questions from our manage­ment about why some peers are doing much better in this market. And we ask them: do you want us to follow their practices? If I suggest something like that, I can be fired on the spot. You have to have some standards.”

Bankers also point to the fact that there are plenty of questions around whether offering discounts to institutional investors is actually legal. For the most part, they are hazy on whether this amounts to an illegal action, but say it has clear signs of market manipulation.

According to the Code of Conduct published by Hong Kong’s Securities and Futures Commission (SFC), when a licensed or registered person and/ or any of its associates explicitly receives monetary benefits from a product issuer (directly or indirectly), it should be disclosed as a percentage ceiling of the investment amount or the dollar equivalent.

In cases of non-explicit remunera­tion arrangement, disclosures around the benefits from the origination and distribution of the product should be made.

The head of high yield is clear on one point: that banks simply cannot sell the same bond at different prices to different accounts.

“Standards tend to slip in a very com­petitive environment,” he says. “When we look at some old deals that were 10 times covered, but went down by 50 points in the secondary, we think something was wrong. It’s key to check the legality of it.”

The SFC declined to comment on the matter.

So where does the market go from here? The Greater China DCM head at the inter­national bank says once a bank starts this process of discounted deals, it can be hard to put a stop to it. The reason? Investors will start counting on the rebate.

“Once you’ve used the practice with some investors, they will ask the rebate the next time too. They will say: ‘Oh, where’s my dis­count?’ and then it becomes very difficult to sell bonds properly.

The DCM syndicate banker at the Chinese investment bank adds: “Lots of bankers have lots of short-term goals these days, with getting a bonus and meeting their P&L. They don’t care if their deals reprice the sector, so long as the deal is done. It’s the worst thing that can happen.”