Volume 11 Number 4 Winter 1999
PREFACE
The recent financial turmoil in
Asia has placed the issue of the development of the Asian bond market
high on the agenda for securing future capital markets. In the beginning
of the 1990s, the World Bank suggested the need to promote the Asian
bond market, an idea that has gained credibility since the Asian
financial crisis. The main causes of the crisis were infiltration
of volatile short-term capital inflows into newly-developing Asian
markets and inadequate foreign debt supervision. In this connection,
there is a strong need to develop the Asian bond market in order
to promote recovery, to restore stability and to reduce the likelihood
of future financial instability. In the same vein, the APEC Financiers
Core Group placed bond market development at the top of the agenda,
and issued several recommendations to promote the Asian bond market.
Asian countries need to enhance their
investments in the capital-intensive manufacturing industry, infrastructure,
housing construction and other sectors requiring a large amount
of capital, in order to maintain economic growth. Developing the
Asian bond market could be a rich source of this strongly-needed
capital. Based upon these premises, the article focuses on two broad
themes. The first is to look at the present situation of Asian bond
market, and the second is to review the causes and effects of its
underdevelopment. In addition, this article aims to consider measures
for developing the bond market in Korea by reviewing recommendations
of the APEC Financial Ministers Meeting.
THE PRESENT SITUATION OF THE ASIAN BOND MARKET
Compared with other world bond
markets, the Asian bond market is relatively small in terms of size
and number of instruments. The combined market size
of eight major developing Asian economies, measured in terms of
outstanding debts (at the end of 1995/96), represented only 6% of
the size of the Japanese bond market.1)
Furthermore, in most developing Asian
economies, debt markets play only minor roles compared to stock
and money markets. For most of Asia except Japan and Korea, the
debt market occupies less than 30% in overall financial markets.
The number of bonds issued in foreign countries reaches only 3%
of the world bond market. (Table 1) On the other hand, the rate
of growth of the Asian bond market is very high. The annual growth
average is at least 20%, twice as fast as those of developed countries'debt
markets. Compared with the role of the stock market and financial
market, however, it plays only a limited role.
Measures
to advance the bond market have been implemented by several developing
Asian economies. Nevertheless, it is moving very slowly because
of various factors. To meet the needs of future capital demand,
vast amounts of capital are needed and raising bond market could
play a major role. In most Asian countries, however, local regulatory
frameworks prohibit the efficient issuing of bonds and make secondary
market trading difficult. Given the importance of debt markets to
finance Asia's future needs, economies need to address key issues
and search for new advantages of cooperation.
THE OBSTACLES OF ASIAN BOND MARKETS
Efficiency
The lack of market efficiency poses the greatest hindrance to development of full-fledged bond markets. The barriers are divided into two main sub-categories: liquidity and infrastructure. What most Asian bond markets lack albeit at varying levels is liquidity, the single most important issue confronting the markets. Lack of liquidity in the bond market is a result of several factors, including supply, demand, pricing and infrastructure.
(1) Supply Side
The
types of bonds and the amount of funds in Asian bond markets are
so limited that ordinary Asian investors haven't been able to actively
participate in bond trading at the secondary market. In developed
economies, government securities play a major role in trading in
the secondary market and the continuous supply of newly-issued financial
securities ensures smooth trading. On the contrary, most of Asian
economies, except for China and the Philippines, have cut the amount
of government-issued bonds in order to reduce the government debts
in line with their balanced-budget policy. While privately-issued
bonds may play a minor role in filling the gap caused by government
cuts, it is insufficient to activate trade in the secondary market.
In general, if the required conditions are fulfilled, the question
of whether to issue bonds or not should be decided by the market.
Yet some Asian governments regulate the types of bonds issued and
the amounts of funds.
In this
connection, there are several obstacles to the development of the
bond market on the supply side.
a.
In general, Asian enterprises prefer short-term resources like bank
loans and equity markets, in order to avoid the restraints associated
with bond listings, disclosure requirements and credit ratings which
pose the risk of lower ratings than competitors.
b.
As most corporations are family-owned, they shy away from publicity
and are thus unwilling to disclose the necessary information for
a bond listing. As a result there is a severe shortage of good quality
issues from domestic corporations.
c.
The governments of Asian countries have issued bonds to compensate
for deficit spending. In Asian bond markets, there are captive markets
for securities due to the existence of large government sponsored
funds, such as the Central Provident Fund (CPF) in Singapore and
the Employee Provident Fund (EPF) in Malaysia which absorb a large
percentage of government bonds resulting in a lack of supply in
the secondary market. Most Asian countries' balanced finance policies
prohibit excessive bond listings, and as a result, the inflow of
bonds into the secondary market is minute. Thus, the fiscal surplus
or minor deficit rate of Asian governments prior to the recent financial
crisis became obstacles for the steady development of the bond markets.
Asian economies except Hong Kong and China, are now decreasing the
amount of local government-issued bonds. As shown in Table 2, the
number of government-issued bonds decreased dramatically compared
to the previous year. The rate of reduced size of local debt markets,
compared to the previous year, are -4.9% in Japan, -42.1% in Korea,
-35.8% in Malaysia, and -75.2% in Singapore.
d.
In Asia, there is almost no bond-trading activity outside of the
market. This is largely due to high intermediary costs and to the
lack of a sufficient pool of intermediaries deemed essential for
creating a demand for bonds that would result in a greater number
of issues being brought to the market. This, in turn, increases
trading expenses. In mature markets like the U.S., the self-registration
system makes bond-issuance relatively easy. In Asia, however, only
Korea has introduced that system.
e.
There are no tax incentives for bond issues which would give corporations
an extra incentives to choose bonds as a preferred method of financing.
(2) Demand Side
Private
investors, compared to institutional investors, relatively have
little information about bond markets. The lack of information for
individual investors have made it impossible to create retail bond
market for private investors in Asian countries, even though they
have high propensity for savings. Furthermore, it is difficult to
find periodical issuing of "household name"bonds needed
to foster the development of a retail investor market.
In
several Asian markets, demands from institutional investors are
regulated by concerned authorities, thus resulting in the few issues
being snapped up quickly and held to maturity. This in turn prevents
the development of active secondary bond markets essential to widening
and deepening development of the bond markets. As for Malaysia and
Singapore, Central Provident Fund, Social Security Trust Fund and
mutual funds consist of 70% of the institutional investors' fund,
because most Asian countries have introduced social security programs
in response to growth of income and the aging of the population.
Investors' perception of stock markets,
that investment in stocks gives 'quick' return, seems to be another
obstacle for development of Asian bond markets. Asian bond markets
also lack the tax incentives for investors to invest in bonds. Due
to insufficient standards of disclosure, compliance and enforcement,
Asian countries lack credibility. They cannot instill investor confidence
during periods of financial crisis, which in turn will decrease
the demand for bonds.
(3) Pricing
Benchmark
yield curves are crucial in the functioning of primary and secondary
bond markets, as they provided a reference for pricing private-sector
debt securities. The slope and the curve reflect the market perception
of interest rate risk, liquidity risk and credit risk. Most Asian
economies, with the exception of Hong Kong, however, have no meaningful
benchmark yield curves or benchmark issues, and this is a key barrier
to the development of bond markets. One reason is that most Asian
governments do not issue bonds actively in line with the balanced
finance policy. Most of issued bonds are to be retained by law until
maturity or to be retained only by financial organizations, and
this adds difficulties to the development of the secondary market.
It is difficult to maintain a reliable
yield curve because of the buy-and-hold strategy of pension funds
and long-term investors. For example, the government of the Philippines
issues Finance Ministry Bonds which mature in 91 days and this determines
the price of debentures. In Korea and China, governments control
the interest rates and this is another limit to the bench mark.
As for Korea, the current Money Security Bonds (MSB) issued by the
Bank of Korea take the place of a benchmark, but the maturity period
of the MSB is limited to two years. In Indonesia where the government
doesn't issue bonds, the money market instruments issued by the
Bank of Indonesia or interest rates of the banks take the place
of bench mark.
On the other hand,
committed "market makers"are important for active secondary
trading. In this respect, market makers should provide the secondary
market with enough liquidity and retain minimal funds for that.
In developed countries, owing to low interest rates, repos or covering
provide the bond market with liquidity. But in Asian countries,
it is difficult to find resources for investors due to the inadequate
system of money flaw, which in turn prevents them from acting as
market makers. Consequently, there is a lack of market makers in
Asian bond markets and it prevents the market from pricing based
on the "supply and demand"in markets.
Strengthening
the secondary bond market is premised on all market participants'free
access to information systems. Most Asian countries are not yet
equipped with such systems, so that they can not provide timely
price information; it is another factor impeding the reasonable
pricing of bonds.
(4) Infrastructure
While
efficient bond trading relies heavily on a credible and rapid settlement
system, in some Asian countries such systems are not yet in place,
exposing investors to risks such as forgery, fraud, and double-trading.
In order to streamline the settlement system, safeguards which can
guarantee the validity, transfer and custody of bonds are also needed.
Such infrastructure plays a crucial role in maintaining investor
trust in bond markets.
Asian developing
economies have not yet set up an adequate and timely process of
bonds issue. One reason is that bond issuers must follow certain
rules, and that may increase trading expenses. In developed countries,
however, a self-registration system has been established, aiding
bond-issuers in conducting transactions smoothly. In Asia, only
Korea has adopted the self-registration system and enacted a law
which prescribes blanket approval.
In
some Asian countries there is not a tax on stocks, yet on bonds,
an laying interests income tax is imposed on bonds, resulting in
a reduced demand for bonds. There also exists discrimination between
natives and foreigners, between individual investors and institutional
investors and between government bonds and debentures.
On
the other hand, some Asian countries have introduced computerized
book-entry systems to deal with trading. It is now necessary to
introduce automatic settlement systems in the remaining countries
regardless of their varying standards in respect to speed of settlements.
Consistency and Comparativeness
In general, Asian countries'account process corresponds with international standards. Enterprises whose stocks are listed should abide by the account process. The degree of development of the domestic financial market should determine the degree of correspondence of the domestic account process to the international standards. Hong Kong, Singapore and Malaysia are equipped with well-developed account systems which meet with international standards. Korea, the Philippines, and Thailand are also equipped with well-developed international account systems which has been adjusted to suit their domestic situations. International account standards must be abided by, especially to promote the participation of foreign investors. In other words, Asian countries should abide by established principles in governing enterprises, and the enterprises themselves should change their attitudes toward trading.
Credit Rating Agencies One
of the major tools for developing bond markets is to establish rating
agencies. Some Asian countries have tried to establish credit rating
agencies and tools to protect investors in developing their bond
markets. China, Indonesia, Malaysia, the Philippines and Thailand
have the rating agencies, but the effectiveness of those rating
agencies varies. As for Malaysia, it is reported that the successful
operation of Rating Agency Malaysia has played an important role
in rapid development of bond markets. In Thailand, Thai Ration and
Information Service operates relatively well in spite of its short
history. In contrast, rating agencies in the Philippines are considered
very inefficient.
The role of
governments is important to develop bond markets and credit rating
agencies. particularly, newly-developing Asian countries should
remove such impediments as surety systems and guarantee the simplified
account and public announcement systems. It is also recommended
that they should enact provisions which encourage enterprises to
use rating agencies.
Governments
should guarantee the adequate rating of bond markets. They should
also remove the guarantee requirements on issue of most bonds, resulting
in hindrance of bond market development. As for Korea, every bond
must be guaranteed by the financial institutions, rendering rating
agencies useless. Competitive environment should be also promoted
so that the quality of credit information is improved.
THE NEED TO DEVELOP THE ASIAN BOND MARKET
Since the beginning of 1990s, the
World Bank, the Bank for International Settlements (BIS) and the
Asian Development Bank (ADB) have suggested the need to develop
the Asian bond market to forge the development of Asian economies.
The need was further highlighted by the financial turmoil in 1997.
Recently, it was pointed out that the capital account crisis was
the essential element of the 1997-1998 Asian crisis. It argues that
the recent Asian financial crisis was a capital account crisis while
those occurring in Brazil and Mexico in the 1980s were current account
crises. If macro-economic fundamentals are weak, the current account
goes into the red, causing a current account crisis. That is to
say, if the finance deficit causes high inflation, this in turn
weakens competitiveness in exports, leading to a deficit in the
balance of international payments. Reduced foreign currency holdings
and then a foreign currency crisis result.
In
contrast, a capital account crisis occurs when the amount of capital
inflow exceeds the amount of financial account deficit. As for Thailand
in 1995 and 1996, the amount of increased deficit to gross domestic
product (GDP) was 8%, and the amount of capital account surplus
to GDP was also almost 8%. This means that the amount of financial
account deficit depends on the amount of capital account surplus.
As a result, with the bubble economy collapsing, a crisis in the
balance of international payments ensued. The inflow of international
capital into domestic markets caused the double mismatch. That is
to say, a maturity mismatch and a currency mismatch came at the
same time, which in turn worsened the financial crisis.
Maturity
imbalance refers to the mismatch between the period of debt maturity
and asset maturity. It occurs when the financial institutions lend
short-term maturity funds to someone with long-term maturity contacts.
In that case, if the owner of the fund wants the financial institutions
to pay immediately, the financial institutions may face a crisis
because of their lack of liquidity. Currency mismatch occurs when
domestic currencies are depreciated against the US dollar. Financial
institutions may borrow US dollars, capitalizing into local currencies.
Then the assets are in local currencies and the debt is in US dollars.
Consequently, if domestic currencies are depreciated against the
US dollar, borrowers would become highly indebted. This suggests
that Asian financial market should search for ways to secure long-term
capital needed to develop industries, or to build the maturity transformation
system. For this purpose, commercial banks, bond markets and stock
markets should intensify their own functions separately. Above all,
the promotion of bond markets is strongly needed to secure long-term
capital.
APEC's RECOMMENDATIONS FOR THE DEVELOPMENT OF ASIAN BOND MARKET
APEC's Discussions to Promote the Asian Bond Market
Since 1994, APEC has been organizing
annual meetings of the APEC Finance Ministers, followed by that
of the APEC Financiers Group, comprising leading financiers from
member countries. A subject discussed in all of these meetings since
1994 has been the development of a liquid and mature debt market
in Asia, an issue which has been high on the agenda of APEC. Additionally,
working committees within APEC have been meeting regularly to forge
the way for the development of the Asian bond market.
The
Finance Ministers meeting in April 1997 endorsed the "voluntary
principles"and "collaborative initiatives."Based
upon this, the paper entitled "Progress in Developing Asian
Bond Markets: An Assessment Framework"was presented at the
APEC Financiers Group Meeting in Kananaskis, Canada in May 1998.
This meeting adopted the proposed assessment framework that APEC
Financiers could use to track progress of their governments over
time, and to determine the most useful ways to further encourage
progress. In 1999, the Langkawi Finance Ministers meeting assigned
"Price Waterhouse Coopers"to build an assessment framework
of the bond market and suggested some recommendations.
The
Kananaskis assessment framework proposed that the countries should
be evaluated against a total of six criteria under three categories:
Macroeconomic Information, Accounting and Disclosure Standards and
Credit Rating Agencies.
In May
1999, in Langkawi, Malaysia, the APEC Finance Ministers' Meeting
classified the evaluation framework criteria into four categories:
Transparency, Consistency and Comparability, Risk Management and
Efficiency. Hong Kong, Singapore, Malaysia and Thailand were selected
as samples, and Chief Executive Officers in those countries were
interviewed. This expanded assessment framework was then used to
evaluate the four sample countries on the present level of bond
market development. As a result, the key barriers to growth in each
market were identified, followed by some key recommendations.
APEC's Recommendations
Based on the four criteria, specified
below are the immediate actions which are recommended for adoption
by the APEC Financiers Group at their Langkawi meeting in May 1999.
The recommendations require varying actions from the countries in
the three different clusters which have been identified as emerging
markets, developing markets and mature markets.
1)
Transparency
a. Emerging Markets:
Improve accuracy and timeliness of publication of macro-economic
information
b. Developing Markets:
While standards are generally acceptable, need to further improvement
on the accuracy and timeliness of information publication
c.
Mature Markets: Provide technical assistance in this area for emerging
and developing market economies
2) Consistency and comparability
a. Emerging Markets: Strengthen corporate
governance, disclosure and compliance rules and regulatory enforcement,
with imposition of punitive penalties on defaulters
b.
Developing Markets: Continue the promotion of a high level of corporate
governance, disclosure and compliance rules and culture
c.
Mature Markets: Provide technical assistance in this area for emerging
and developing market economies
3) Risk Management
a.
Emerging Markets: Improve the quality of local rating agencies in
cooperation with global rating agencies to attract foreign investors.
In the short term, consider setting up a fund to absorb part of
the cost of local credit rating agencies to enable them to issue
both solicited and unsolicited ratings with the view of building
up their credibility and reputation in the market. the attachment
of bank guarantees to bonds should be discouraged.
b.
Developing Markets: Risk management standards should be upgraded
at generally acceptable level.
c.
Mature Markets: Provide knowhow to local credit rating agencies
in emerging markets to enhance their market image and reputation.
Through moral suasions, encourage multinationals to take the lead
in investing in selected issues rated by local credit rating agencies,
as an endorsement of the credit rating agency (CRA)'s credibility.
4) Efficiency
a.
Liquidity: Increase demand by retail investors
-
Emerging Markets: Encourage retail investors by making it mandatory
that a certain percentage of selected bond (e.g. that of 'household
names' be issued in smaller 'retail size'denominations. Sponsor
and encourage investors education programmes through television,
seminars and advertisements in magazines and newspapers.
-
Developing Markets: Encourage retail investors by making it mandatory
that a certain percentage of selected bond (e.g. that of 'household
names' be issued in smaller 'retail size'denominations. Sponsor
and encourage investor education programmes through television,
seminars and advertisements in magazines and newspapers. Develop
a computerized information centre to collect and disseminate bond-related
information to potential investors. Create conditions for and encourage
banking institutions to develop the swap market which is currently
small and undeveloped. Remove restrictions on foreign investors
to swap their investment process into foreign currencies before
exiting the market.
- Mature Markets:
Government and supranational agencies could buy bonds issued in
emerging and developing markets, to complement traditional aid packages.
Sponsor investor education programmes promoting bond issued in emerging
and developing countries.
b. increase
supply of quality investment grade bonds
-
Emerging Markets: Encourage, through the granting of tax incentives
and moral suasion, the issue of bonds by major in corporations private
sector, expecially those 'household names.'Replace Non-Performing
Loans in banking sector with government bonds. Promote the issuance
of asset backed securities. Allow local banks to transact repo agreement
in local currency, initially with banks and subsequently with non-bank
investors to fuel activity in th short term secondary market. Promote
the local issuance of high-quality US$ and Yen bonds. Develop and
support a long term benchmark yield curve.
-
Developing Markets: Encourage, through the granting of tax incentives
and moral suasion, the issue of bonds by major corporations in private
sector, especially those 'household names.'Issuing NPLs should be
prohibited in genenal. Promote the issuance of asset backed securities.
Allow local banks to transact repo agreements in local currency,
initially with banks and subsequently with non-bank investors to
fuel activity in the short term secondary market. Promote the local
issuance of high quality US$ and Yen bonds. Most developing markets
already have a developed benchmark yield curve.
-
Mature Markets: The U.S. and Japanese governments could take the
lead in issuing US$/Yen bonds locally in the emerging and developing
markets to increase supply. Government and supranational agencies
can assist in enhancing credit ratings through guarantees of local
government bonds, as a alternative to traditional aid packages.
c. Efficiency: Infrastructure
- Emerging Markets: Implement an efficient
"one-stop"centre with a built-in 'default approval'system.
Make all bond issued tax exempt. Strengthen legal systems, bankruptcy
laws and efficiency of the courts, especially regarding to settlement
failure and bonds default. Increase, through the granting of incentives,
the number of market makers and global intermediaries. Link local
clearing systems to Euroclear and Cedel.
-
Developing Markets: Generally, approval systems are satisfactory.
As in emerging markets, all bond issued to be tax exempt. Although
situation is better than in emerging markets, it could be further
improved. Although the number of global intermediaries is satisfactory,
there is still an absence of market makers, which needs to be rectified.
Encourage exchange trading relative to OTC by reducing the transaction
costs.
- Provide technical assistance
in the implementation of a "one stop"approval system,
an investor-friendly tax regime and a conducive legal environment.
The actions should be driven at both
international and local level. Local task forces, endorsed by the
Ministers of Finance, and comprising representatives from the regulatory
authorities and the private sectors should be given a mandate to
develop their respective countries'bond markets, based on an action
plan (incorporating relevant recommendations from this report) coordinated/supported
by a central APEC committee.
The
successful development of the Asian bond markets will result in
a "win-win"scenario for all parties. There will be significant
benefits to all stakeholders, governments and regulators.
PROSPECTS FOR THE FUTURE
APEC's initiatives for promotion
of the Asian bond market should include various elements such as
strengthening corporate governance, raising the quality of local
rating agencies, and promoting the domestic bond markets. furthermoer,
it should include ways for improving financial systems. Above all,
the promotion of bond markets is the key issue. With high savings
rates, Asian investors have excess money to invest for higher returns.
On the other hand, the public sector has an enormous need for financing
infrastructure developments. A well-developed bond market could
channel the excess savings from individuals to the public sector
and to corporations in a cost-effective manner. In addition, tapping
Asian funds will reduce the risk of borrowing volatile foreign funds.
To this end, Japan has tried to widen the role of the yen in the
international market through investing in bond markets. This will
help to promote the Asian bond market. Japan, the most powerful
bond market in Asia, is likely to take initiatives in promoting
the Asian bond market by supporting Yen bonds. In the same way,
Asian countries need to develop bond markets and will try to forge
policies to promote their domestic bond markets.
The
essence of APEC's recommendations for the promotion of Asian bond
market is to prepare voluntary action plans for reducing the barriers
to the development of the bond market. therefore, APEC member countries
should evaluate their own domestic bond markets voluntarily, according
to the proposed evaluation system and establish action plans relevant
to domestic markets.
The Korean
bond market is the second largest in Asia, and therefore, it is
strongly recommended that it should do its best to promote the domestic
bond market for securing stable funds and to internationalize and
enhance the role of the won. In conclusion, the Korean government
should prepare voluntary and active plans for the development of
the domestic bond market.
