The Asian Development Bank has made the development of local currency markets in Asia one of its priorities in the drive to shore up the region's abilities to withstand financial crises. The intent is allied to ensuring the kind of transparency and, in turn, mobilise savings to buttress the region's financial markets. William Rhode reports.
In November 1999 Singapore’s Prime Minister Lee Hsien Loong, chairman of the Monetary Authority at the time, gave a speech to the Asian Bankers Association in which he outlined the lessons to be taken from the Asian financial crisis of 1997.
Second on his list, after a need for strong banks, was the importance of developing deep and liquid local currency bond markets in the region.
“There is now widespread recognition that Asian countries depended too heavily on bank loans for financing,” he said. “Domestic banks lent excessively. Foreign banks also went on a lending binge in Asia in the years leading up to the crisis in 1997, and just as surely accounted for the bulk of the sudden withdrawal of capital in the two years that followed. Had Asia relied more on bond and equity financing, they would have had alternative sources of financial intermediation, and the subsequent credit crunch in the banking system would have had a smaller impact on the real economy.”
He continued: “Bonds and equities offer significant advantages over bank borrowing. They are a means of long-term financing and investment to corporates, unlike short-term credit lines, which mean funds being pulled out of a company at the first sign of trouble. They facilitate asset-liability management. They mobilise savings and widen the range of investment alternatives for both institutional and retail investors. They create transparent market-determined assessments of creditworthiness.”
And it is for these very reasons that the Asian Development Bank (ADB) has made the development of local currency bond markets a priority in its effort to help the region re-emerge from the financial crisis and establish strong financial systems, said Masahiro Kawai, special adviser to the president of the ADB and head of the office of regional economic integration.
“Fully functioning local bond markets are crucial to the economic development and stability of Asia,” said Kawai. “And I’m pleased to say that the regional economies have made good progress. It’s a gradual process but I am very optimistic about the future.”
According to the latest edition of the ADB’s semi-annual Asia Bond Monitor (ABM), released in March 2006, emerging East Asia is generally outperforming other countries in terms of financial deepening.
Bank lending and equities deepen
Having said that, Asia’s bond market deepening, which captures the sum of both the government and corporate bond markets, is less impressive than its banking sector and equity market deepening, with only Malaysia showing above-average performance (see figure).
Another test of bond market deepening is how corporate bond market activity compares with private bank financing activity in the economy, known as the corporate bond/private bank financing ratio.
According to the ABM report for 2002-2004, most emerging East Asian economies, with the exception of Malaysia, fell around the international benchmark, indicating a relatively balanced financial sector. While Malaysia has a bond market-biased financial system, Hong Kong, China and Singapore have a bank-biased financial system.
The report concludes: “On the whole, emerging East Asian economies will have to work harder to deepen corporate bond markets and they need to explore policy initiatives to attain larger corporate markets, such as through those of the Asian Bond Market Initiative (ABMI) and the Asian Bond Fund (ABF).”
Said the ADB’s Kawai: “The ABMI has probably been the most important initiative for helping Asia develop its local currency bond markets. In addition to our support for its working groups advising on policy, we have stimulated the market through issuance. In fact, we have been so successful in this area with the ADB, the IFC (International Finance Corp), and JBIC (Japan Bank for International Cooperation) all issuing bonds that the authorities have successfully closed the working groups that were set up to concentrate on issuance.”
Next on the list for the ABMI is to tackle settlement and clearing.
“There is no regional system for settlement and clearing,” said Kawai. “At the moment Asia still relies on the European clearing system which means that there is significant exposure to Herstatt risk.”
The ADB is also helping authorities set up a regional credit enhancement mechanism to guarantee bond issuance, in much the same way that the securitisation industry uses collateral to improve issuance rating.
“Small and Medium Enterprises (SMEs) can get together to issue collateralised bonds,” says Kawai. “We have to be careful in this area so as not to invite and moral hazard or bad behaviour on the part of SME issuers but we’re paying a lot of attention to this.”
The ADB is also assisting regional credit rating agencies to improve their capacities and ratings comparability across Asia.
“One of the peculiarities of the region is that there are a lot of local credit rating agencies,” said Kawai. “You don’t see that anywhere else, only in Asia. While there are problems with this – principally in terms of their limited capacity and the lack of comparability between them and the international ratings – there is a role for these agencies. The larger international rating agencies won’t rate smaller corporate issues, but local agencies do, so if we want to encourage the supply side, then local rating agencies can help.”
He adds: “What we need to do is to encourage convergence among the country-specific agencies and try to bring their methods under one umbrella, one that is more in line with international standards. Ultimately, there may be a case for a pan-Asian rating agency.”
Kawai said that the ADB cannot fulfil the role of a pan-Asian rating agency but it is actively supporting the Association of Credit Rating Agencies in Asia (ACRAA) in this regard.
“One thing we are doing is helping individual countries that want to set up credit rating agencies to do so,” says Kawai, adding that Vietnam is currently considering the process.
Finally, the ABMI is looking to issue multi-currency bonds.
“This could take several approaches,” says Kawai. “We could issue a bond based on a basket of Asian currencies, or we could issue bonds in one Asian currency and have the interest payments linked to another Asian currency.”
A slow boat
But critics say that, while ADB may be full of good intentions, it has made little concrete progress in developing local currency bond markets.
Said a trader at an international bank in Singapore: “The ADB has been trying but frankly, the road to hell is paved with good intentions,” he said. “Forty years ago when Europe developed its bond market, it set definite rules – no borders, one language, two rating agencies, two clearing houses, delivery against payment. Out here things are an absolute mess. That’s because none of the hard issues have been addressed.”
Kawai says the problem is complex.
“For a successful issuance market, a lot of market infrastructural development – disclosure, accounting, credit ratings, auditing, a legal framework, and a market in securitised instruments – still needs to occur. This doesn’t happen overnight.”
There are difficulties on the demand side as well.
“There isn’t a lot of investor diversity in Asia,” said Kawai. “Commercial banks are big investors but they tend to buy and hold. We need to see more transactions taking place. And there needs to be more development of the pension fund, mutual fund, and insurance industries in Asia so they can participate in both the primary and secondary trading markets. Without a successful secondary market, the bond market in Asia can’t flourish.”
He added: “And while the ADB can try to disseminate information, which we’re doing through the ABM and the Asia Bond online website, as well as holding international conferences and forums to promote Asian capital market development, we are limited by the disparity of the region. Ultimately, we can only advise governments on policy to help nurture bond market infrastructure.”
A pan-Asian bond market
The holy grail remains to one day see a unified pan-Asian bond market that brings the regional differences of language, currency and law under one umbrella. To that end, the ADB says it will focus on promoting convergence and focussing it on international best practises.
“The upside of the situation is that there’s a healthy sense of competition in the region,” Kawai said. “Rather than pursuing their own separate strategies in a bubble, a lot of Asian countries are looking at what their neighbours are doing and either imitating them or seeking to out do them. There is a healthy exchange of information and, really, it’s becoming a joint effort.”
But the trader remains cynical: “Thailand teaching Vietnam how to build a bond market is like my twelve year old son trying to teach brain surgery just because he took a biology class. Ultimately, these markets have to be born out of necessity.”
He cites the example of Thailand, which practically built a yield curve overnight because the government issued a rash of bonds to raise desperately needed funds in the wake of the financial crisis.
“Between 1989 and 1998 there were no sovereign debt issues from Thailand,” he explains. “But since July 1998 there been the equivalent of US$66.8 billion in Thai baht government bonds issued. Like I said, at the end of the day, it’s all about addressing the hard issues.”