Stephen Yan-leung Cheung Professor (Chair) of Finance Department of Economics and Finance

Bond Markets in the Pacific Rim:Development, Market Structure and Relevant

Issues in Fixed-income Capital Markets

Stephen Yan-leung Cheung

Professor (Chair) of Finance

Department of Economics and Finance

City University of Hong Kong

Stephen Cheung Bond Markets in the Pacific Rim 2

1. Economic Situation

• Asian Region– Fast growth– Setback during the Asian Financial Crisis– A rebound in 2000– Slowdown because of the slowdown in US

economy– 911 incident


2. Asian Equity Markets

Index Performance

0

0.5

1

1.5

2

2.5

96 97 98 00 01 02

Year

Ind

ex

Hong Kong

Japan

Taiwan

Korea

Singapore

US


2. Asian Equity Markets(IT Bubble)

Index Performance

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

97 99 00 01

Year

Ind

ex KOSDAQ

GEM

NASDAQ


3.1. Balanced Financial Market

Table 3.1.1. Outstanding bank loans, bonds, and equity markets in South East Asia, December 1998 (US$ billion)

Country / Economy Bank loans Corporate bonds Equity market

Indonesia 60.21 1.5 16.2

Korea 43.5 27.3 30.7

Malaysia 148.4 5.1 134.4

Thailand 108.7 2.6 26.3

U.S. 38.8 43.2 158.1

1 At the end of 1997.

Source: Kim, Y.H. Policy Agenda For Bond Market Development in Asia, In Bond Market

Development in Asia, OECD, Paris, p.143.


3.2. International Bank Lending to Asian Countries

Table 3.2.1. International bank lending to Asian countries

December December June December June December June December June

1996 1997 1998 1998 1999 1999 2000 2000 2001

Total Developng Countries (TD) 692.6 891.7 860.7 836.6 895.4 877.2 860.5 873.8 828.8

Total Asia (TA) 367.1 378.8 319.6 299.0 287.1 270.9 282.6 275.2 251.3

Indonesia 55.5 58.0 48.4 44.9 45.0 41.7 40.4 40.2 36.9

Korea, Republic of 100.0 93.7 71.6 65.5 67.2 64.8 61.1 58.8 52.8

Malaysia 22.2 27.3 22.8 20.9 18.8 18.6 17.3 20.8 21.6

Thailand 70.2 58.5 46.4 41.2 39.4 32.4 29.0 26.6 23.1

China 55.0 62.8 58.7 58.4 72.3 63.5 61.3 58.2 53.8

Taiwan 22.4 26.0 22.5 20.9 20.4 21.0 19.3 18.1 16.1

Total Selected Asian Countries (TS) 325.3 326.3 270.4 251.8 263.1 242.0 228.4 222.7 204.3

(TA/TD)% 53.0 42.5 37.1 35.7 32.1 30.9 32.8 31.5 30.3

(TS/TD)% 47.0 36.6 31.4 30.1 29.4 27.6 26.5 25.5 24.7

Average Maturity (Selected Countries)

Less than 1 and 1 year (%) 63.0 62.8 56.5 55.6 49.3 48.1 49.5 46.4 47.6

Average Maturity (Total Asian Countries)

Less than 1 and 1 year (%) 61.5 60.3 53.0 52.5 51.4 51.0 47.6 44.9 45.9

Source: BIS, “Consolidated International Banking Statistics”, various issues, 1998-2001.


3.3. Net Private Capital Flows to Emerging Market (US$ billion)

Table 3.3.1. Net private capital flows to emerging markets (in billions of U.S. dollars) 1992 1993 1994 1995 1996 1997 1998 1999 2000

Emerging markets

Total net private capital inflows 116.9 124.3 141.3 189.0 224.2 126.2 45.2 71.5 32.2

Bank loans and other 28.5 -14.0 -49.5 49.5 18.7 -62.1 -127.2 -135.6 -172.1

Net portfolio investment 53.0 81.6 109.9 42.6 85.0 43.3 23.8 53.7 58.3

Net foreign direct

investment 35.5 56.7 80.9 96.9 120.4 144.9 148.7 153.4 146.0

Asia

Total net private capital inflows 15.0 41.5 67.1 74.4 113.9 18.9 -55.4 2.0 -2.6

Bank loans and other -12.7 -9.5 3.4 6.3 31.2 -48.4 -119.1 -88.4 -97.8

Net portfolio investment 12.9 18.0 18.9 19.7 27.1 7.1 6.5 36.6 45.9

Net foreign direct

investment 14.7 33.0 44.7 48.5 55.5 60.2 57.2 53.8 49.3

Source: IMF (2001), “International Capital Markets: Developments, Prospects, and Key Policy Issues”, p.43.


4. Asian Crisis

• Lessons– Maturity mismatch– Currency mismatch

• Liquid and Mature Bond Markets Stabilize– Banking sector– Corporate sector


5. Market Value of Listed Bonds at year end (US$ billion)

Table 6. Market value of listed bonds at year end (US$ million)

1995 1996 1997 1998 1999 2000

Hong Kong NA NA NA 110,438 98,910 89,401

Indonesia 405 339 109 50 21 165

Colombo NA 5.3 46.6 64.4 70.2 NA

Japan 3,886,535 3,821,540 3,600,291 4,472,648 5,263,913 5,083,839

Korea 162,421 208,167 132,222 277,788 321,697 335,718

Malaysia 3,497 3,444 1,788 1,310 1,753 1,563

Philippines - 6 4 0 0

-

Singapore 150,539 161,239 171,626 182,946 198,939 218,792

Taiwan 31,813 36,750 32,919 36,578 44,284 48,445

Thailand 1,945 927 351 352 155 NA

Source: International Federation of Stock Exchanges, web site www.fibv.com

NA : Not Available - : Not Applicable


5. Market Value of Listed Bonds

• From 1995-1999:– Japan increased by 35%, Korea by 99%,

Singapore by 32%, and Taiwan by 38%

• In 2000:– Korea, Taiwan and Singapore increased

marginally– Others declined


6. Advantages of Developing the Asian Bond Market

• Fast growth region (?)

• High saving rate of 30%

• Large number of infrastructure projects

• Growth of pension and provident funds


7. A Deep, Liquid and Mature Bond Market Will…

• Lower the cost of government borrowing by helping to mobilize domestic saving more efficiently

• Help implementation of monetary policy

• Provide risk management instrument for investors and borrowers

• Introduce great discipline on corporations and governments

• Help development of the derivative instruments on interest rates

• Help solving the Non-performing loan problem


8. Preconditions of a Successful Bond Market

• Adequate supply of high quality issuers

• Adequate demand by institutional investors

• Rating and good disclosure standards

• Standardization of papers and procedures to facilitate trading and liquidity of market

• Favorable tax and transaction costs

• Infrastructure for payment, clearing and settlement both regionally and internationally

• Clear and fair regulatory framework


1. Benchmarks

– No benchmark curve

– Some have short benchmark curve no more than three years

– Very thinly traded, only indicative

– Could be helped by the issuance of local currency denominated debt paper by the multilateral agencies, such as WB, IFC, and ADB

9. Issues in Development of Debt Markets


2. Regulatory Framework

– Heavy bureaucratic control– Regulatory framework in many countries is

also unclear in the secondary market– No legal clarity, domestic and foreign

investors are unwilling to take legal and regulatory risks




2. Regulatory Framework

– Overlapping and multiple regulatory regime impede market development

– Effective regulatory regime should meet the international standards

– Regulatory framework should be developed jointly by the market participants and the regulators


Box A: Tax incentives and other measures

• Exemption for profits tax on income derived from Hong Kong dollar bonds issued by multilateral development banks.

• Concessionary tax rate on other private sector Hong Kong dollar bonds with 5 years maturity or longer.


3. Market Infrastructure

– Some Asian Papers still in bearer form and shorten the the settlement periods

– The lack of an efficient market infrastructure increases payment and settlement risks

– Hong Kong has introduced the Central Moneymarkets Unit (CMU) and the RTGS payment system to decrease the settlement and payment risks



Table 9.3.1. Indicators of good financial infrastructure

Country Creditor rights * Judicial system

effectiveness**

Quality of

information***

Hong Kong HIGH HIGH HIGH

Indonesia LOW LOW LOW

Korea MEDIUM MEDIUM MEDIUM

Malaysia MEDIUM MEDIUM MEDIUM

Philippines LOW LOW MEDIUM

Singapore HIGH HIGH MEDIUM

Taiwan LOW MEDIUM MEDIUM

Thailand MEDIUM LOW MEDIUM

Source: Raw data from Herring and Chatuscripitak, “The case of the missing market: The bond market

and why it matters for financial development”, pp. 15-17, Asian Development Bank Institute

Working Paper # 11, July 2000.



Box B: An efficient, reliable and low cost clearing and settlement

1. Hong Kong Monetary Authority developed Central Money Unit in 1990, which cleared initially the Exchange Fund Bills and Notes, and later private sector bonds.

2. The system was further linked up with the Hong Kong dollar interbank payment system to provide DVP.



4. Ratings

– The presence of international rating agencies is limited– Limited understanding of the local culture and situation– Local credit rating agencies, frequent failure experience– Joint venture with an international partner– Make the credit rating mandatory during the listing

process– Should not deviate from the international standards



5. Demand

– A high saving rate of 30 %– Increasing income and aging population– Growing pension fund, about 1% of GDP would be

added annually to institutional investors– Commercial banks hold the debt papers for liquidity

purposes– Some governments have removed tax disincentives on

bonds, discriminatory taxation of bonds between local and foreign investors



Table 9.5.1. Foreign reserves and savings rates in Asia-Pacific economics

Foreign reserves

2000

(US$ billion)

Savings ratio

1999

(%)

China 166 40

Hong Kong 108 30

Singapore 80 52

Thailand 32 33

S. Korea 96 34

Malaysia 29 47

Indonesia 22 32

Philippines 13 20

East Asia 901 36

Australia 17 22

Japan 347 28

U.S.A 31 18

Germany 50 23

U.K. 39 16

Source: International Financial Statistics, IMF;

World development indicators 2001, World Bank


Box C: Mandatory Provident Fund (MPF)

• The scheme was launched during 2000. Employed and employer need to contribute 5%.

• US$1.3 billion, or 1% of GDP in the initial year of operation.


6. Supply

– Removal of discriminatory tax policy may invite foreign issuers

– Let the foreign companies to tap into the domestic market

– Traditional Asian corporations prefer bank loan than bond market because they do not want the rating results to make public and do not like the feeling of being rated especially incase of bad rating and the rating fee is relatively high.

– Restructuring of the state-owned enterprises and the troubled corporate sector in the crisis-hit economies

– Mindset



7. Secondary Markets

– Mainly by commercial banks

– Big domination

– Securitization and innovative debt financing structures such as asset-backed and mortgage-backed securities

– Brokers have no incentives

– Banks have no incentives

– Lack of the market-making process



Box D: Narrow investor base

• At end-1999, banks and financial institutions held around US$11 billion or 84% of the Exchange Fund paper and around US$16 billion or 43% of the private sector paper.

• The rest is held by a few institutional investors, such as the public funds and pension funds.


Box E: Secondary Market

• In September 1999 the Hong Kong Monetary Authority and the Stock Exchange of Hong Kong arranged to list Exchange Fund Notes on the Exchange.

• The board lot size was reduced to face value of US$6,141 to promote retail investor participation.


8. Corporate Governance

– Accounting standards – Accountability– Information disclosure: Accuracy and timely– Important for international investment community– Setting up audit committee and include outside

directors– Internationally acceptable standards such as OECD

standards



9. Human Resource

– When the market is booming, hard to find qualified financial analysts for the government agencies that have to compete with the investment banks with better offers

– Staffed with young graduates who will move to the market when the market is booming



10. Education – Return/Risk analysis

– Investor– Broker

Financial Planning



11. Regional Cooperation to promote the Asian Debt Market

– Better infrastructure for clearing, settlement, and payment systems

– Better coordination in trading, clearing, payment, regulation, listing to enable mutual listing of debt securities across different markets

– Linkage of domestic depositories will enhance trading and holding of Asian bonds by domestic participants, hence enlarging the investor base and improving the liquidity

– No euroclear, a need to develop Asiaclear



12. Political Will

– Formal management structure for the project (leader, coordination, supervision)

– Identify clear priorities and sequencing in reforms

– Consensus among key players; regulators, investors, brokers, and issuers

– Strong leadership

– Ensure strong interaction among players


~ END ~

Stephen Yan-leung Cheung Professor (Chair) of Finance Department of Economics and Finance

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