Reg S: Comes face to face with the world’s greatest liquidator

Fortress Asia has held fast since the global financial crisis struck in 2008, but there is certainly no room for complacency. While another full-blown crisis seems unlikely, a less-severe shock is certainly possible. Somewhat bizarrely, Asia’s resilience has made it both a haven from the turmoil in more developed markets and a destination for investors looking for decent returns and a credible growth story. Huge amounts of money have flowed into the region over the past 12−18 months. This is a positive story, but this inflow of foreign capital is also eerily reminiscent of the “hot money” that poured into the region in the run-up to the Asian financial crisis. Likewise, 2012 has been a record year for US-dollar bond sales in Asia, but short-term foreign debt − both sovereign and corporate − was a major contributing factor to the devastation of 1997. Poor corporate governance was also a feature of the Asian turmoil 15 years ago and events, surrounding companies from Sino-Forest in China to the Bakrie Group in Indonesia, show scandals are also back. Could a repeat of the Asian crisis befall the region again? There are some disturbing similarities – and some reassuring differences – between Asia today and 15 years ago. In fact, much of the region’s present-day strength can be attributed directly to the lessons learnt and reforms undertaken in the wake of the 1997 turmoil. The recovery almost came too fast for Asia and, with the good times, there is always a risk that policymakers may take the foot off the pedal. Asian governments, for one, learnt a great deal. Many have since adopted floating exchange rates, so their central banks will not be forced to spend huge chunks of their foreign reserves to maintain pegged exchange rates (Thailand spent all of its reserves during the Asian crisis). If Asia’s central banks did look to shore up their currencies, they each have far more foreign reserves at their disposals today, while the Chiang Mai Initiative promises to provide a regional alternative to IMF assistance. Asia’s banks, even after considerable balance-sheet expansions in recent years, are very well capitalised – in part because the crisis forced Asia to adopt the kind of banking reforms and consolidation that Europe and the US are undertaking at the moment.Local liquidity Another major difference is that Asia has worked very hard, and with considerable success, to develop its local currency debt markets to reduce dependency on offshore debt. Local currency bonds have come so far that Thailand now plans to turn all of its sovereign debt into baht. Given that Thailand is where the Asian financial crisis began in June 1997, it is quite an achievement that the Kingdom has built a baht bond market that now matches its Bt8trn (US$268bn) bank market. Likewise, the Philippines, although not a victim of the Asian crisis (due to its being an underachiever before the crisis rather than prudential fiscal management), has clearly learnt the value of liquid local currency markets. It has embarked on several liability-management exercises aimed at turning dollar liabilities into peso debt, and has been a pioneer in selling local currency bonds to global investors. Indonesia, Malaysia and South Korea have, equally, worked hard to develop local currency bond markets. Deeper local capital markets reduce the likelihood of a repeat of the Asian crisis because companies that have borrowed in their local currencies are sheltered from exchange rate movements. This also limits contagion, because one of nastiest effects of falling exchange rates is the way they can quickly turn good companies into bad ones even if they hold only modest levels of foreign debt. In addition to local bond markets, individual wealth is also changing the Asian liquidity landscape. “Singapore has emerged as a major private banking and investment management centre. So now more Asian money stays in Asia and is managed in Asia. Private banks are now providers of liquidity. Ther

The last 12 months have reversed the traditional mix in Asia. The current year has been an outstanding one for Asia’s debt capital markets, just as equity issuance has faded. Is this a function of rates and markets, or is there a more significant shift taking place? The increase in debt-capital-market volumes has been momentous. Total Asian debt issuance in G3 was US$115bn up to early November in 2012, compared with US$73bn for the whole of last year. “You’re talking about a 48% increase year to date and the year hasn’t ended yet,” said Paul Au, head of DCM syndicate at UBS in Hong Kong. Moreover, it has been a fairly broad-based improvement. “The issuance has been across the region, from many different countries, with a good mix of corporate and sovereign issuance and a pick up in high yield issuance.” One interpretation is that the increase, and the decline in ECM volumes, is a function of temporary circumstances. “It’s part of a global phenomenon of record low interest rates and credit spreads that have been tightening through the year,” said David Ratliff, head of investor sales and relationship management, Asia Pacific, at Citigroup. “You’ve got US Treasuries at all-time lows, and in a lot of local currency markets you’ve also seen rates come down to dramatically low levels. Issuers are taking advantage of that.” At the same time, equity issuance has been problematic in such difficult markets. “It’s been challenging for ECM,” said Herman van den Wall Bake, head of fixed-income capital markets for Asia at Deutsche Bank. “The reduced growth prospects in the region, and the fact that margins have come under pressure, have impacted valuations and investor appetite. Many companies have opted not to dilute themselves at these levels and have looked at the debt market instead.” However, there are broader shifts at work, too. If this was just a case of people ignoring equities for all forms of debt, there would have also been a rise in loan volumes, but that has not been the case. “It’s not a function of leverage all of a sudden going up,” said van den Wall Bake. “The syndicated loan market is down 20% year on year. Instead, what you’ve seen is a trend away from bank financing and towards bond financing.” People have been expecting this to happen for some years, but the exceptionally high liquidity among Asian lenders has stopped it from taking place. Earlier this year, however, banks globally began to be squeezed and the term and quantum of lending began to change. “Hong Kong blue chips, instead of getting five- or seven-year loans, were only getting three-year loans,” van den Wall Bake said. With margins on those loans increasing, too, as banks passed on borrowing costs, bonds started to look much more attractive. “The minute bond markets reopened in January, there was a stampede of corporates trying to lock in term funding,” said van den Wall Bake. “As the year progressed and we saw base rates rally and credit spreads tighten, the appeal of terming out debt was compounded.” This has become increasingly clear through the current year as rates from the perspective of issuers have got better and better. Take Hutchison Whampoa, for example. It launched five- and 10-year bonds in January, raising US$1.5bn at 3.5% and 4.625%, respectively. It returned in November for the same volume and tenors, this timing paying 2% and 3.25%, respectively. “Basically, they’ve saved themselves 150bp in the same year, with just 10 months in between,” said van den Wall Bake. On top of that, there is a continuing change in the nature of the Asian investor base. This manifests itself in a number of ways, from the growth in the number and scale of sovereign wealth funds, to the steady development of pension funds, and the increasing appetite for debt securities among private-banking clients. “The Asian investor base has become a lot more independent, which means issuers from the region are able to depend a lot more on Asian investors alone for their issu

While Asia is clearly better positioned than most other regions of the world to weather the ongoing economic storm in Europe and the US, it is, of course, not immune. With growth rates in China, Japan and India reaching multi-year lows in 2012, most of Asia is feeling the pinch. This economic distress, and the competition for natural resources, has exacerbated nationalist tendencies – always lurking beneath the surface, due to Asia’s diverse cultural, linguistic and religious mosaic. The result is an aggressive form of political and economic nationalism that is threatening the concept of Pan-Asianism and making foreign investors think twice about investing in some Asian countries. Natural-resource nationalism is evident in a variety of countries and has manifested itself in a number of ways, ranging from more restrictive foreign-investment policies, to trade restrictions, to militarism. For example, earlier this year, the Indonesian Government adopted new rules that sharply increased the costs of doing business in the mining sector. Foreign mining companies must, within 10 years of commencing production, cede majority control of their businesses to the government. Recent legislation also imposed a 20% tax on scores of unprocessed minerals. These actions are clearly designed to increase government control over the sector, at the expense of foreign investors. Earlier this year, Australia passed a 30% tax on coal- and iron-ore-mining companies, designed to promote infrastructure development in the country. These measures send a distinctly anti-foreign-investment message, which will have a long-lasting negative impact. The other major area of concern is a rising propensity towards militarism – both between regional powers, and on the grand global chess board between China and the US. The high-profile conflict between China and the Philippines over the Scarborough Shoal and, over the longer term, between China and five other Asian nations over the Spratly Islands is evidence of this, as is competition for superior blue-water military capabilities between China and India. The stage is set for rising expenditure in support of superior military capabilities throughout the region, which will only heighten the propensity towards militarism and negatively impact already-strained national budgets. Nationalism and militarism combined this year in a higher-stakes dispute between China and Japan over the Senkaku Islands (the Diaoyu Islands to the Chinese and the Tiaoyu Islets to the Taiwanese), and between Japan and South Korea over the Takeshima Islands (the Dokdo Islands to the Koreans). In neither case does it appear that the spats will result in overt military action between the countries, but the economic costs will be high. Japan invested more than US$6bn in the PRC last year and, although China is Japan’s largest trading partner, trade between the two countries fell 1.8% in the first nine months of 2012. In September alone, China’s imports from Japan fell 14% year on year, having a profound impact on the Japanese economy.Fanning the flames None of the governments of these countries appear to have much interest in resolving the conflicts swiftly, preferring instead to fan the flames rather than pursue international arbitration. One reason is that domestic politicians so often utilise nationalism to achieve their own objectives, and the average citizen is more likely to rally around the flag than consider thoughtfully the consequences of their governments’ actions in territorial disputes. Another reason is that so many Asian governments continue to be products of their own histories, and have little interest in moving past these with their neighbours – even though it would clearly be in their long-term interests to do so. For instance, at some point in time, a Japanese Prime Minister will refuse to visit the Yasukuni Shrine simply because Asia is living in another era. However, until electorates choose to put into office enlightened lea

To John Wright, CEO of Global Sage, this has been the toughest year of his career. “If banks in Asia have felt the crushing pressure of miserable business and flagging margins, then the financial services recruitment industry felt it doubly. In 2012, nobody was hiring; nobody was paying; and no one is likely to do those things in the foreseeable future.” Harry O’Neill of Heidrick & Struggles set the scene. “It’s been pretty rough,” he said. “The first half of the year was terrible. By November last year [2011], things had slowed down decidedly, and the normal hiring season just didn’t happen. All the activity you expect to see in November and December, with people starting searches to hire in February and March once people had been paid bonuses, didn’t happen. Banks were cutting staff and deal activity was very low.” Things have improved since and “every month has been a little better than the month before”, but it is still a far cry from the good times. In such an environment, financial services businesses have had to reshape in order to survive. Christian Brun at Wellesley Partners, for example, says that in a difficult year, his house has done a lot of work on the asset-management side, particularly around private equity and hedge funds. Wright claims Global Sage has “been ahead of the curve in terms of implementing changes, but has had to do a complete rethink of its strategy and approach to executive search”. A key change, he says, has been to diversify the client base: “We’re not wedded any longer to the traditional investment banks as much.” Areas of momentum have included a range of asset management, risk, corporate and insurance work, as well as anti-money-laundering and technology. Global Sage has changed strategy more than many financial recruitment groups, having undergone not one, but two mergers or alliances in the space of 12 months. In the first deal, announced in January, it sold a stake to Bó Lè Associates, the general executive search firm focused on China with a growing South-East Asian presence. In June, it signed an agreement with The Rose Partnership, the London-based financial services headhunters firm. They are interesting moves. Bó Lè’s stake gave Global Sage badly needed funding to do other things, but the firm has a different model, covering not just banking, but consumer and retail, industrial and manufacturing, new media and pharmaceuticals. Subsidiary BRecruit is different, too, focusing on mid-level positions and large recruitment projects. Rose Partnership looks a lot more like Global Sage, with a focus on investment banking, risk and compliance, wealth management, private equity, asset management and board practice. So, is headhunting now a scale game? “Absolutely,” said Wright. He will maintain his firm’s global tilt. “I think there’s a lot more to be done in North and South America. In terms of strategic direction, that’s where a lot of our focus is going to be.” In traditional investment banking, clients are still trying to work out the right business model that is going to revive them. “You cannot run the sort of businesses that all the investment banks have been running in this new world,” said O’Neill. “Under Basel III, it doesn’t make sense.” That is not to say, however, that the good times are gone forever. “If you look at the banking industry, it has been very good at regenerating itself through hundreds if not thousands of years, and this is another one of those exercises: figuring out what the new model looks like and how to make money from it,” O’Neill said. Brun agreed. “Investment banking in Asia is going through a secular change and it’s not going to come back in the form it was before. Even if markets come back, people are going to have to reconfigure themselves in a new world, focusing on profitability rather than share of wallet or league tables as they did before.” Big hires have still taken place in this environment. One of the biggest was the move of Deutsche Bank’s fo

With central banks dampening the appeal of the world’s three biggest currencies, many of Asia’s currencies have emerged as star performers and are set to build on that trend in 2013. Asian currency units, outside Japan, have continued to attract attention despite bouts of extreme risk aversion. The eurozone sovereign debt crisis remained the main source of investor fright. Yet, at times throughout 2012, fears of a hard landing in China led to heavy selling of high-beta assets in the region and currencies closely tied to the PRC growth story. It was mid-2012 when one of the first worrying signs began to emerge out of Asia. The spot price of iron ore, a key raw material for China’s construction sector, began to freefall in early July. Concerns over what this meant for China’s many close trading partners in Asia were far from unfounded. Reports were awash with anecdotal evidence of large-scale inventory stockpiling in China, as well as offshore miners scaling back their investment plans. Private surveys also showed a noticeable drop in foreign orders for Asia’s manufactured goods. The spectre of a hard landing in the world’s second-largest economy awakened the China bears just as the eurozone crisis was intensifying. Those most pessimistic had Greece making an exit from the euro, and Spain, Ireland and Portugal needing bailouts. Fears of a global slowdown sent key commodity prices plummeting with the spot price of iron ore plunging almost 40% in just two months from early July to the start of September to touch levels not seen since the 2008–09 crisis. Meanwhile, trade data from Asia’s “workshop of the world” disappointed, as the headwinds from Europe challenged their economic models. Exports from China, the hub of the Asian supply chain to the West, decelerated from double-digit growth rates to just 1.0% per annum in July, while imports contracted 2.6% in the year to August. In South Korea, exports fell as much as 8.7% in the year to July and did not grow again for the next two months. Meanwhile, Taiwanese exports fell 11% in July and another 4% in August, and Malaysian exports dropped a much as 5% over the same period. Indonesia’s exports were among the worst hit, falling as much as 24.3% year on year in August.From gloom to boom In this environment, investors headed for the safety of risk-free, low-yielding bonds, resulting in Triple A sovereign debt yields plummeting to zero or even, in some cases, turning negative. Investors with cheap central bank funding shied away from emerging Asia in search of better returns. The prospect of a hard landing in China had them putting money in US equities. During the height of the eurozone crisis, between early May and early June, the MSCI Asia ex-Japan Equity Index fell nearly 5% against the S&P 500, as the HSBC Asia ex-Japan currency index fell close to 2.70% against the US dollar. Fears of a catastrophe in Europe, however, faded fast after ECB President Mario Draghi declared “we will do what it takes to save the euro!” The unveiling of the bond-buying programme (OMT) backed up the claim. Even though the scheme has yet to be triggered on a request from eurozone countries (Spain, in particular), its introduction was enough to push down yields of stressed sovereigns and buy time before the next phase of the crisis. Chinese manufacturing and growth numbers eventually improved, too, as did trade data from other emerging Asian powerhouses, mitigating concerns that the PRC was in for a rapid slowdown. By the time of the US presidential election, the investment world looked like a safer place. Global stock markets were steaming higher, credit spreads were tightening; currency option volatility was trading at four-year lows, and the VIX index traded at levels not seen since before the financial crisis. The re-election of President Barack Obama soon gave way to fears of another round of budget brinkmanship ahead of the so-called fiscal cliff, resulting in a slide in global equities and a retu

Was 2012 as good as it gets for Asia in the G3 bond markets? The answer hinges on whether you’re of the belief that this record-breaking year for new issues represents secular – and sustainable – market growth, or if it is simply inflating a bubble that is set to burst with inevitably painful consequences for all concerned. Time, of course, will tell. Yet, there can be little doubt that one element of the debt equation – the US rate curve – was a crucial component of the perfect storm for Asia’s G3 markets in 2012. The fact that Asian issuers (excluding Australia and Japan) placed US$134bn of new debt against the backdrop of some of the loudest headline noise yet out of the eurozone and low-octane growth in the US, China and India was nothing short of remarkable, and there was no repeat of the eurozone-inspired market shutdown of late 2011. Indeed, if 2012 was anything, it was the year that 2011 should have been, with eurozone fatigue, perhaps, explaining why the Asia G3 juggernaut has kept rolling along so relentlessly. Undoubtedly, the credit component came of age in Asia’s primary markets this year, with unrated paper, perps and challenging high-yield and credit-enhanced issuance managing to cross the line. However, 2012 would have been different had the US Treasury market not spent the year drifting down to yields not seen since the Second World War. In the process, the global “quest for yield” became a well-worn cliché, used to explain why so many new issues were coming to the market, and why they were greeted with such dizzyingly high order books – whether in Asia, or North and Latin America. Investors didn’t want the microscopic yields available on Treasuries, so they went for anything that gave them something above that. In those circumstances, investment grade became effectively a proxy for US Treasuries and was the easiest asset class for syndicate bankers to bring to market. The ease with which deals priced was in part a reflection of the fund inflow dynamic that was in place for much of the year. As of November, according to research firm EPFR, emerging-market funds had registered their 21st week of inflows, with EM-dedicated bond funds averaging inflows of around US$600m per week. Also, in a year when Asian private-bank portfolios weighted fixed-income more heavily over equity than before, the bid was there for anything offering an optically attractive return. Doomsayers claim that the PB bid is a toxic phenomenon, rooted in rebates bookrunners paid to wealth managers, leverage offered to customers and the cause of the rampant book inflation that was 2012’s signature theme.Private parties Moreover, they envisage that, when the rate cycle turns and a full-scale portfolio switchback into equities occurs, the PB bid will quickly evaporate. That would help hammer the secular growth theory, but, as the year comes to a close, there’s no sign of that bid retreating. This was starkly evident in one of the year’s most “risk-on” propositions: a US$500m unrated perpetual from China’s Shui On Land. Some 55% of that trade went into the hands of private banks in early December, marking the culmination of another seemingly unlikely phenomenon in 2012 – the return of the China property bond. After the bloodbath in China property stocks and bonds in October 2011 – stemming from fears that the sector was in hock to China’s shadow banking industry at sky-high rates and facing an insurmountable refinancing burden – issuance from the China property companies dried up. To many, a revival was unthinkable, in the face of not only the refinancing pressure, but also contracting sales and declining prices. In the end, China’s property companies managed to get financing onshore and hoarded cash, while sales and prices picked up. Just as it rounded off the China property issuance year, Shui On also reopened it in launching a US$400m three-year in February, flamboyantly defying the sceptics with two further taps of the deal and paving the way

IFR Asia reviews 2012 in cartoons A selection of some of the best cartoons published during 2012 in IFR Asia. To see the digital version of this report, please click here.

IFR Asia reviews 2012 in charts Please click on the arrows to scroll through the graphics published during 2012 in IFR Asia. To see the digital version of this report, please click here.

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Some alternative definitions for the themes of the year To see the digital version of this report, please click here.