Asia bond markets and local currency issuances: bond program and structuring considerations

Asian bond market issuance has been growing rapidly over past few years however competitively priced bilateral bank loans remains the elephant in the room for bond markets. As at end of June 2014, the total issuance by both corporates and governments outstanding reached US$9.5 trillion, including India, of which government bond markets stood at US$4.8 trillion. The Asian bond market is expected to grow exponentially in future with improved economic growth, infrastructure development, regulatory, governance, and economic and social conditions in Asia.

Direct investor access to government bonds in Singapore, Malaysia, Philippines, Indonesia, India, Korea, Taiwan, China, dimsum CNH HK is now possible via direct access whilst registered with central banks and via synthetic funds. Investors also participate in the LCY bond markets through various participants of which popular access is through HSBC Asian Bond Index and the JP Morgan JACI Index. Of all the markets, China has emerged as the largest bond markets.

Investor and issuer participation in the local currency (LCY) bond markets has accelerated on account of few key reasons

emergence of local currency liquidity pools in Asia and the development the CNH, dimsum and samurai markets. The emergence of RMB as a new currency has increased issuance base.
the creation of Asean+ 3 forum and ADB's active involvement that seeks to set up governance and regulatory conditions for investing.
improved investor sentiments and governance though retail investor participation is still lower while family offices, promoters, and state owned pension funds dominate participation.
improved credit and governance transparency and the active role of rating agency.
issuances by the governments both locally and internationally.
investor and issuer friendly regulations; the active investor education and awareness.
investors increasing appetite for an exposure to non-USD currency especially Chinese RMB and Indian Rupee to diversify their risk, capture higher yields and participation in Asia's growth and improved credit and FX profile. EU and US funds are also actively seeking higher yields and diversifying their portfolios
many bank lenders are constrained by Basel 3 regulations restricting its ability to provide long term bilateral loans

Asian fixed income as an asset class has delivered superior returns over the past decade due to a combination of yield advantage, currency gains and declining risk premiums. International investors are also diversifying exposures by investing in local issuance and a risk mitigating factors. As these returns have come with falling market volatility, it has given Asian fixed income a distinctive attribute of having a superior return to risk ratio. The better performance by Asian countries have also improved credit risks and appreciation in foreign exchange rates.

On the issuer front, LCY bonds are helping corporates to tap local funding pools, widen investor base, and tap new products like MYR sukuk, CNH, THB or INR issuances, green bonds, catastrophic linked bonds and infrastructure bonds. The investor appetite to green and catastrophic bonds is limited to Japan and few issuers in the region though lately these issuances are gaining traction with issuer awareness; marginal price differentiation between regular bonds and these structures restricting issuances with increase issuer participation. Infrastructure bonds issuance by corporates are not in vogue due to long tenors, lack of government guarantees, domination of bank lending and complex regulations in the local markets.

Local issuance sometimes require local rating; improved credit rating by local agencies or no need for rating as company rides on strong local reputation is also helping issuers to price sharper issuance compared to USD.

Sophisticated issuers of LCY bonds are creating a natural hedge to their exposures in emerging markets thus moving away from pure vanilla hedges. Example cross border investments and loans are increasingly funded using LCY issuances that self-fund a natural exposure or local funding hedges local long positions on expenses or investments or assets. In many local markets, an inverted FX curve for local currency issuances provides a positive kicker to a fully hedged USD bond. In Malaysia and China, the kicker has from time to time has provided about 1.5% per annum of positive return.

The bond markets are gradually opening up in Asia, the progress is slow as central banks cautiously weigh the impact of capital flows on the economy, volatility of its currency and socio-economic and political stability of the country.

Some important considerations for structuring LCY issuance and investments options:

Evaluate local markets and investor limitations, if any. Local foreign exchange and capital market regulations both for issuer and the participant can significantly impact the depth and breadth of the markets and consequently the issuance size.
Credit rating options and risk premium are essential to evaluate pricing. Assess local agency rating versus international ratings as local ratings may be better than international ratings. Evaluate option for an un-rated issuance that leverage on corporates local reputation and the cost of premiums. Investors may be willing to accept a lesser risk premium for a reputed corporate which may not be rated.
Withholding tax and capital gain tax implications on total interest cost. Many jurisdictions allow corporates to use the withholding taxes payments to offset its overall corporate tax liabilities though capital gain tax cannot be offset.
Proactive arranger and advisor that understands the business needs and the FX model will always help in pro-actively accessing the market whenever the opportunity emerges in terms of liquidity and overall cost reduction.
Determine the group functional currency and understanding global exposure of the group to identify natural hedges. Issuing in LCY which hedges a natural exposure in LCY provide immense advantages and reduced overall cost to the company. Companies with large USD revenues and USD linked asset base use USD as its functional currency; LCY issuances are then hedged back to USD; FX hedge help strip off FX cost of LCY issuances.
Pro-actively set up of multi-currency notes (MTN) program structures to quickly access active pools in Singapore dollar, Thai Baht, Indonesian Rupiah, Indian Rupee, Malaysian Ringitt, Chinese Remnimbi. Structures to provide issuance that could cover sukuk, convertibles, perpetuity, commercial papers, and bonds.
Package structures with arrangers that cover issuance plus foreign exchange risk swaps at no extra cost or margins. The mismatch in foreign exchange swap market tenor can restrict ability of corporates to hedge its exposures thus impacting tenors and risk profile; most foreign exchange swaps are not liquid beyond 3 years.
Investors need to understand and analyse (i) the accessibility of an individual country market as most markets require registration, (ii) withholding tax and capital gain tax implications.
Evaluate capital structures and interest rate swaps to ensure that the interest cost reflect the correct funding cycle i.e. short term funding and interest rates should apply to short term utilisation.