Wednesday, 12 December 2018

On the boil

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Has the recent relaxation of investment rules in Taiwan ushered in an issuance bonanza in offshore currencies from the country, or is it just an arbitrage-driven flash in the pan?

Regulatory change in 2014 involving a reclassification of Formosa bonds laid the foundation for an issuance boom in the product. This came alongside a drying up of the Dim Sum market and caused many to ponder whether the Taiwanese renminbi market was about to eclipse its better established Hong Kong neighbour’s. The jury is still out.

In November 2013, Taiwan’s Financial Supervisory Committee (FSC) allowed Taiwanese and foreign banks to issue in renminbi using the Formosa bond market.

This comprises foreign currency issuance in Taiwan’s domestic bond market, usually through listing on the GreTai exchange, and which is subject to domestic regulations and taxes. Mainland Chinese banks rushed to bring deals after the deregulation, accounting in late 2014 for 65% of total Formosa bond issuance.

Further regulatory change in April last year lowered the funding cost for foreign issuers listing their bonds in Taiwan while the classification of Formosa bonds issued by offshore entities and cleared offshore spurred issuance.

Bringing deals in the Formosa bond market is subject to local regulatory approval and local tax is payable on the issuance and this, together with the relatively poor liquidity of the market, explains why renminbi-denominated Formosa bonds historically have yielded less than Dim Sum bonds, although increasingly there is yield convergence.

The regulatory approval for renminbi-denominated Formosa bond issuance resulted in a surge in investment by Taiwanese insurers in the product.

And a regulatory change in April last year, with a consequent switch from low-yielding Taiwan government bonds, prompted a rise in local domestic government bond yields.

Taiwan life insurers have foreign investments capped at 45% of their portfolio, hence the reclassification prompted a mass switch into Formosa bonds.

And with long end yields around the 2% mark and most Taiwan insurers adopting a 4% hurdle rate, these companies are natural buyers of offshore fixed-income assets, and they are increasingly shopping around to achieve or exceed this hurdle.

The freeing up of the local life insurance investor base has resulted in increased demand for offshore paper in dollars as well as renminbi.

Still, this blossoming comes with a health warning for offshore banks hoping to grab wallet by selling down Formosa paper; if they are not licensed in Taiwan they face penalties from Taiwan’s FSC. Barclays’ Taipei branch was fined NT$12m (US$384,000) in December for selling offshore securities without a licence in Taiwan.

The booming renminbi-denominated Formosa bond market has been music to the ears of DCM bankers who had been staring down into what appeared to be the demise of the Hong Kong Dim Sum market.

Issuance in that market has slowed to a trickle this year as monetary easing by the mainland Chinese authorities reduced borrowing costs in the domestic markets and rendered Dim Sum issuance uncompetitive.

Opening demand

The vast pool of renminbi located onshore in Taiwan is the biggest outside mainland China and much of the funds sit with life insurance companies.

As well as the opening up of demand from life insurance companies, issuance was driven by a rosy arbitrage scenario for issuers, particularly in renminbi, where post-swap savings from renminbi into dollars were irresistibly advantageous.

Ironically this came about just as a spike in onshore renminbi deposit rates in Hong Kong suddenly made the Dim Sum market look profoundly unattractive.

Three-year rates spiked up from around 2% to 4% earlier in the year and issuers were simply unwilling to fork out for the higher coupons demanded.

“For a long time, the Dim Sum market was a one-way trade predicated upon the stability of the renminbi FX regime. With Hong Kong cast as the gateway to China, investors had the luxury of an attractive carry play,” said Andrew Stephen, head of Asian private placement and local currency at Deutsche Bank in Singapore.

“Now that we’re seeing more volatility in the currency, the investor mentality has shifted and this has increased volatility in the bond market.”

According to data from Thomson Reuters, issuance in Formosa bonds has risen from US$1.27bn-equivalent in 2013 via seven deals, to US$2.4bn-equivalent via 10 deals in 2014, to US$2.3bn-equivalent via 12 deals so far this year.

“Dim Sum has had a hard time of it in Hong Kong, thanks to monetary policy easings on the mainland that suddenly made it look less competitive in yield terms versus the PRC onshore market,” said Jon Pratt, head of Asia-Pacific DCM at Barclays in Hong Kong.

“But it will come back, partly due the mechanical function of rising renminbi deposits in Hong Kong. But also because of yield and spread normalisation in the US dollar fixed income markets and the consequent search for high quality diversity.”

Far from demise

This comment was apposite coming as it did just just after PRC computer manufacturer Lenovo priced the largest corporate Dim Sum bond to hit the market in more than a year (with Barclays on the trade), a Rmb4bn (US$645m) five-year that garnered a chunky Rmb20bn book via 234 accounts. The Dim Sum market, on the evidence of this unrated trade, is far from its demise.

“Taiwan’s bond market is traditionally yield rather than forex-driven. There is a natural inclination among the onshore investors towards Taiwan dollars, but they also show interest in US dollars if they can swap back at a premium to Taiwan govvies”

“We were just on the Lenovo deal, which was the Dim Sum market’s largest single tranche offering and which for an unrated deal just goes to show that the right name with the right structure and price can clear this market,” said Pratt.

He pointed out that the Formosa market, while having had an auspicious time of it, was hitting a bottleneck whereby the yield hurdle at the Taiwanese lifers was increasing, while issuers were loathe to pay the returns demanded.

“Formosa bonds have had a great run and are here to stay, but yield targets are more discerning now on both the buy and sell-side. Particularly notable has been a rising yield hurdle at the Taiwanese life companies, where the buying surge of the past few years has given way to something more ambitious. It’s a classic market process of maturing,” said Pratt.


The one-dimensional nature of the Dim Sum market has long been a talking point of market participants: it has been regarded as little more than a call on the foreign exchange value of the renminbi and its ability to deliver tenor beyond five years non-existent due to the unwillingness of counterparties to commit on a long-dated swap. By contrast, the Taiwan dollar market is driven by the need of onshore institutional investors for carry.

“Taiwan’s bond market is traditionally yield rather than forex-driven. There is a natural inclination among the onshore investors towards Taiwan dollars, but they also show interest in US dollars if they can swap back at a premium to Taiwan govvies,” said Stephen.

“The drop in US dollar yields through early parts of this year resulted in a US corporate issuance slowdown, but this is more of a blip, than a structural stymie. As US Treasury yields rebound so will issuance volumes.”

Interestingly, the Formosa market has been able to deliver at 20 and 30 years and callable bonds are allowed, making the arena a rather tantalising alternative to straight Dim Sum. Indeed, Barclays Pratt sees the Formosa market stepping into the breach for long-tenor dollars should the US dollar offshore market in Asia shut.

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