In the region, annual domestic corporate bond issuance reached US$758.4 billion in 2009, an increase of 1.5x since 2005. Last year alone, local issuance jumped 38 per cent.
This momentum partly reflects concerns about the future ability of banks to meet borrowers’ needs as banks conserve balance sheets to comply with Basel III capital adequacy requirements. Governments are also looking to local corporate bond markets to bolster resilience to any future global shocks. They recognise the role well-functioning corporate debt markets play in resourcefully allocating capital and aiding the common goal of regional financial integration.
Fixed-income debt market can also help investors efficiently grow their wealth over the longer term. This is a key benefit, given the region’s aging populations, likely rising inflation, and higher costs of living.
Robust credit cultures are built on key elements
Fostering a credit culture goes hand-in-hand with bond market development. Risk should be measured and priced according to objective standards, and not based on questionable relationships and implicit assurances. A global best-practice credit culture would produce an attractive and rewarding environment in which investors can operate. In our opinion, the chief elements would be:
- Transparency — disclosure, high and consistent reporting standards, and good corporate governance.
- Independent and objective credit analysis — high quality and credible research and analysis in a competitive environment.
- Risk-based pricing — compensation for investors’ risk-taking.
- Creditors’ rights — bankruptcy laws and a legal system that enforces these rights.
- Arm’s-length relationships — between issuers and investors, and between governments and banking systems.
A healthy credit culture thrives on a bottom-up approach in which investors drive the market. It is also based on the free flow of reliable and independent information. Lastly, it is about equal treatment and a fair and level playing field. Again, in countries where relationship-driven preferential treatment has taken precedence it will be up to regulators and policymakers to eradicate entrenched sub-par practices.
Some governments are concerned that bond markets could create social instability as a result of introducing direct default risk into the market. But risk is inherent in all investment systems and business and financial activities. An overly heavy reliance on banks has the potential to exacerbate social instability. A bond market shifts risk toward those willing to take it on and reduces the potential impact on society.
Big issues driving the momentum include: investors’ need to grow wealth more rapidly to offset global aging and likely rising living costs; the region’s generally urgent need for infrastructure investment; and the need for companies to diversify funding sources in bank-dominated environments. Asia Pacific governments and their markets strongly sense the importance of developing deep and liquid debt markets as an essential next step in achieving the sophistication of the US or Eurozone markets.
Australia
Credit culture
Australia has high governance, sound accounting standards, and a rigorous regulatory regime. Creditors typically have few problems in enforcing rights. No preferential relationships are imbedded in the market, and the government does not have much of a direct ownership role.
Local bond market development
The long-term domestic bond market in Australia has more than doubled in the past five years to about A$700 billion. The government bond market is highly liquid, but the non-bank corporate sector is still relatively small and illiquid. The domestic capital markets still struggle to compete with the syndicated bank loan and offshore capital markets.
The investor’s perspective
Investors benefit from a strong culture of independent credit analysis from credit rating agencies, independent research companies, and the media. Shareholder activism is strong. Australia’s efficient risk-based pricing is an attraction in government and bank bond markets.
China
Credit culture
Independent credit analysis of domestic debt is in its infancy in China. Corporate governance standards and risk-based pricing are still being developed. Media scrutiny is increasing, but new bankruptcy laws are yet to be fully tested. While creditors’ rights are improving, they are not consistently enforced.
Local bond market development
China’s bond issuance has increased by 60.0 per cent in each of the past two years. China is the largest corporate bond market in the region (ex-Japan). Its strong growth momentum is likely to continue as corporate China continues to search for cheaper funding and the government further encourages bond market development.
The investor’s perspective
China is opening its doors to foreign investors and issuers, with a greater variety of bonds available, with different risk and return profiles. The development of an investor-focused corporate bond market will depend largely on the banks’ willingness to share information they have accumulated internally.
India
Credit culture
India has a sound and improving credit culture. Objective and independent credit analysis has increased investor comfort in the debt markets, and the rating agencies have helped the market to move from relationship- and name-based pricing to arm’s-length pricing that factors in underlying credit and liquidity risks. Corporate governance standards are strong and improving, and the legal framework has strengthened considerably in recent years.
Local bond market development
India’s corporate bond market is small but growing rapidly. The outstanding stock of corporate bonds in June 2010 was US$156 billion, about 12 per cent of India’s GDP. Public debt issuance is limited. India is estimated to require US$1 trillion in infrastructure investment over the five years from 2012. This will require large amounts of specialised debt. Bankruptcy laws limit a lender’s ability to enforce securities in a timely manner.
The investor’s perspective
India’s strong and improving credit culture is attractive to investors. Information is transparent and readily available, and arm’s-length relationships exist between investors and issuers. The removal of investment rules that constrain insurers and pension funds would greatly benefit the Indian bond market. Most bond market investors in India operate in buy-and-hold mode. Such investors typically look for highly rated paper, which dampens demand at the lower end of the rating scale.
Japan
Credit culture
Japan has come a long way in terms of information disclosure and transparency in the past two decades. But disclosure can still be quite selective, especially among the major banks. The country’s five credit rating agencies provide a high degree of objective and independent analyses. Risk-based pricing is relatively sound, but banks’ lending portfolios can have a fair degree of mispricing.
Local bond market development
The global financial crisis has dampened bank lending and resulted in new issuance growth. Japan’s bond market (excluding government bonds) has grown by 7.1 per cent to ¥61.4 trillion in the five years ended 2009. Corporate bond issuance rose to ¥11.4 trillion in the same year, compared with less than ¥6.0 trillion in 2004. A loss of confidence in structured finance securities has also contributed to recent corporate bond market growth, as some issuers have left the structured finance market and obtained funding in other markets.
In our opinion, the bond market has not reached its potential due to the ample and low-cost liquidity the banks generally provide. Japan’s bond market is the largest in Asia, but it is still dwarfed by a bank loan market of more than ¥460 trillion outstanding in 2009.
The investor’s perspective
We believe a change in investor mentality could further deepen the Japanese bond market. While many institutional investors have established highly sophisticated practices to capture credit investment opportunities over the past few years, many investors — in particular pension sponsors — remain overly risk averse and still more concerned about avoiding defaults than achieving portfolio returns. In our view, a greater focus on returns could open up the high-yield market as well as create more activity in the secondary market.
Korea
Credit culture
Korea’s credit culture is developing. Corporate governance regulations and policies are yet to become deeply embedded. Accounting principles are solid and international financial reporting standards are to be introduced from 2011. Financial disclosure is reasonably transparent. Investor-issuer relationships are becoming less entwined and the government’s influence on the banking sector has diminished. Creditors’ rights are well defined and protected.
Local bond market development
Korea’s bond market is Asia’s third largest. In 2009, issuance reached Korean won (KRW) 740 trillion (about US$640 billion) of which KRW150 trillion was in corporate bonds and KRW590 trillion in government/treasury bonds. More than 90 per cent of corporate bonds are rated by domestic credit rating agencies in the ‘AAA’, ‘AA’, or ‘A’ rating categories, and there is virtually no high-yield market. The tenor of corporate bonds is usually less than three years, which makes it difficult for investors to find long-term opportunities. This in turn forces them overseas.
The investor’s perspective
Korea’s corporate bond market continues to be somewhat issuer oriented. We believe that to gain the support of local and overseas investors the market needs to: more efficiently perform risk-based pricing; more accurately assess credit risk; and more effectively engage in long-term product development. A fully functioning bond market could then deliver much-needed liquidity to high-yield-rated companies, and reduce Korea’s heavy reliance on bank loans and the volatility of its equity markets.
Tom Schiller is Executive Managing Director and Head of Asia-Pacific, Standard & Poor’s.
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Re:…. Despite good progress, Asia Pacific still has a long way to go before its local corporate bond markets realize their full potential. Fostering national credit cultures built on transparency, creditors’ rights, and independent and objective credit analysis is essential….
Tom has raised some very interesting points in the context of the Wall Street inspired GFC, the Asian Crisis of late 1997, the “foreign currency” wars as well as the status of creditor nations China, East Asia and the Middle East:
• Wall Street and London has been the global financial and banking centre reflecting their legacy as the centre of the now fading US hegemonic system. These centers, among other things, recycle foreign trade surpluses from creditor Asian and Middle East nations based on the USD reserve currency system. Our present reality raises the following questions with regard to the status quo:
o The western countries from the UK to USA to the EU will be unable to solve their economic and financial problems thru currency debasement because the problem is to EXTINGUISH historically high public and private debt;
o France, Germany and China etc are concerned with Barnanke’s manic money printing which has created Middle East etc global social instability thru USD exported inflation leading to prospective USD collapse and its replacement by a new mechanism based on a transitional SDR or directly into a basket of currencies (less USD and more Renminbi weighted) and perhaps gold and silver at a revalued price;
o The IMF and Worldbank will either replaced or have concurrent peers more attentive to BRIC concerns;
o It is common sense that China as the creditor nation and the new global economic locomotive will soon become one of the world’s financial and global centre at the expense of London and Wall Street. Note how Frankfurt will acquire New York stock exchange and Singapore’s SGX will be the senior partner in the SGX-ASX merger;
China has initiated bilateral currency swaps with its trading partners and intend to cautiously replace USD for its financial and trading purposes;
o Washington destroyed the regulatory over-sight of the Glass-Steagall act put in place after the 1930 depression and neutered all oversight on Wall Street. The US economy became a speculative and unrestricted debt driven economy causing the GFC and has gamed the financial system including its statistics;
o US credit rating agencies failed to properly assess credit risk thereby enabling Wall Street banks, US Real Estate companies, Fannie May and Freddy Mace to create leveraged derivative products on and off balance sheet that are viewed as fraudulent and simply non-commercial. In summary the credit rating agencies and their customers failed to undertake competent due diligence and fiduciary duties.
China in 1994 created their own private owned Credit Rating Agency to ensure there is transparency and rigorous credit rating because of the failure of their US peers to date: http://www.dagongcredit.com/dagongweb/english/rs/index.php
Note how their assessment of the US economy is more relevant: http://www.bloomberg.com/news/2010-11-09/china-s-dagong-downgrades-u-s-to-a-on-quantitative-easing-xinhua-says.html
The neo-classical ideology placed contra-factual faith in a self-correcting free-market ideology and how credit is created as well as derivative algorithms assuming a “normal risk” distribution that ignored the nature of near equilibrium dissipative complex systems and tenets of Austrian. The western world bought into the Washington Consensus and Miton Friedman’s view on how the economy works;
• The Asian Crisis of 1997 and the present EU member Sovereign Crisis was created when speculative private money flows pulled out and immediate demand for debt repayments caused tax payers to pay the price for bad judgment by banks and bond holders.
o Housing debt in the west including Australia became a bubble because the banks encouraged people to buy homes by lowering the deposit amounts and terms therefore increasing demand and prices until the average borrower reached the limit of its ability to pay. Steve Keen, for example, analysis shows Australian “Ratio of House Price Index to Disposable Income per Dwelling” was 100per cent on 1970 and 250per cent in 2010 whilst number of people in a dwelling has gone down.
o Malaysia survived the crisis thru capital controls despite conventional advise from IMF and Wall Street etc;
o Iceland is recuperating better than other European countries such as Ireland and Spain Etc by refusing Banking interests demands to pay up and insisting the banks accept a haircut;
We in the West have in the past accepted the need for governments to balance the need of both private and public interests to ensure we enjoy both economic growth and a healthy society with a growing Middle Class. China will no doubt find its own solution with regard to how it will use and create credit for its national interests.
The oil exporting countries in the Middle East can no longer afford to tie their currencies to USD without increasing inflation and they cannot simply buy-off their population thru subsidies as well as taking into account religious strictures on interest rates etc.
In summary, I suggest Tom’s prescription on what Asia Pacific will do will be decided by the needs and ideas of the Creditor nations