There’s a certain irony in the way that private equity and hedge fund investors, usually from outside Asia, are providing the capital to many companies within Asia, despite the huge pools of capital sloshing around the region, notes Robert Morse, chief executive of Citi, Markets & Banking Asia Pacific, in Thursday’s FT Insight column.
In many instances, rules and regulations are holding back Asia’s domestic bond market and the deployment of much of this capital around the region.
Yet, a combination of regional growth - Citi predicts 8.3 per cent regional GDP growth for 2008 - and healthy corporate balance sheets means Asian fundamentals remain strong.
Equity market volatility, however, undermines the argument that Asia has decoupled from the US, notes Morse. And while the region has shown resilience to the US liquidity crisis, what it really needs to mitigate further negative impact is better infrastructure in its capital markets. A key step in Morse’s view would be development of the region’s local-currency bond markets.
Asian governments have had some success in developing these markets since the 1997-98 financial crisis: Asian local currency bond issuance across the region now totals more than $100bn a year and in Singapore and Hong Kong, offer a serious alternative to the international bond and bank lending markets, according to Morse.
Before the 1997 crisis, Asian corporations issued virtually no bonds, let alone bonds denominated in local currencies floated in local bond markets. Even today, bank funding constitutes a majority of all fixed-income funding.
Despite the growth in Asian bond issuance, structural problems remain. At the most basic level, market infrastructure is still patchy and most Asian local corporate bonds are never actively traded. International issuers face a gauntlet of red tape in some markets and some have been known to call it quits after six months of legal work. Many local and international investors are restricted in what they can buy and trade.
All this has led to an illiquid market in which it is costly for companies to issue bonds. In today’s credit environment, investors are wary of buying assets they cannot sell quickly, adds Morse.
While banks have set up active trading desks across the region, it is largely government bonds that are traded. Local corporate bond flows are minimal, and there is little incentive to either issue or buy local bonds - especially by international participants.
Market regulators can help solve these problems by providing tax incentives to investors to trade local corporate bonds and changing regulations to make it easier for foreign investors to participate in such markets, thereby reducing the “illiquidity premium”, argues Morse.
Many investors and issuers are also taxed for participating in Asia’s local bond markets, ranging from taxes on borrowers issuing debt to those on investors buying debt and on the trading of debt. The relaxation of such taxes would help the market’s development. Another way to help development would be to shift some of the more than $2,000bn of Asian government foreign currency reserves into actively managed local bond funds. This strategy has been tried, with limited success, by supranational institutions. But their efforts have not boosted liquidity as these funds are largely passive buy-and-hold investors.
An active Asian sovereign wealth local bond fund would help market development. It would also recycle some of Asia’s sovereign wealth back into Asian locally home grown businesses.
Active derivatives markets are also needed, says Morse. Global investors are reluctant to dip into markets when they can’t hedge their risks. But regulations in many Asian countries hinder the development of derivatives.
The bottom line for Asia’s domestic bond markets, concludes Morse, is that regional regulators will have to “exhibit some of the vision they have shown in the past decade” before these markets can come of age.
