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Regional Bond Markets: Rationale, Concerns and Roadmap

S. Ghon RheeS. Ghon RheeK. J. Luke Distinguished Professor of Finance K. J. Luke Distinguished Professor of Finance

Executive DirectorExecutive DirectorAsia-Pacific Financial Markets Research CenterAsia-Pacific Financial Markets Research Center

University of HawaiUniversity of Hawai‘‘ii

For Presentation at the Hong Kong Committee for Pacific Economic Cooperation-Hosted Luncheon

March 23, 2004 Hong Kong SAR

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Two Questions

1.1. How much are Asian bond How much are Asian bond market activities integrated market activities integrated with global market with global market activities?activities?

2.2. Why do we need a regional Why do we need a regional bond market?bond market?

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Reality Check of Regional Bond Market Activities (I)

Fact 1: Fact 1: Active Participation of Asian Active Participation of Asian Investors in Asian Bond Investors in Asian Bond Issues Issues

71 bonds (US$41.2 billion) issued by Asian 71 bonds (US$41.2 billion) issued by Asian borrowers in April 1999-August 2002borrowers in April 1999-August 2002

44%-46% of these bonds were purchased by 44%-46% of these bonds were purchased by Asian investorsAsian investors

Source: BIS Study Source: BIS Study (2002)(2002)

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Reality Check of Regional Bond Market Activities (II)

Fact 2: Fact 2: Active Participation of Asian Active Participation of Asian Borrowers and Investors in Borrowers and Investors in

Singapore Bond MarketSingapore Bond Market

Bonds Issued (US$ Billion)Bonds Issued (US$ Billion) 20022002 20032003

S$-bonds S$-bonds 1 10.42 0.42 11.11 11.11 (27% by Asian Issuers in 2002)(27% by Asian Issuers in 2002)

Non-S$ bonds Non-S$ bonds 1 11.06 1.06 22.7522.75 (40% by Asian Issuers in 2002)(40% by Asian Issuers in 2002)

Who are the Buyers?Who are the Buyers?

Source: MASSource: MAS

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Reality Check of Regional Bond Market Activities (III)

Fact 3: Fact 3: Active Participation of Asian Active Participation of Asian Investment Banks in Investment Banks in International Bond Issues International Bond Issues

Borrowers from 6 Asian countries raised Borrowers from 6 Asian countries raised US$53 billion, 1991-2001US$53 billion, 1991-2001

1/3 of these issues: Asian investment banks1/3 of these issues: Asian investment banksSource: Park & Bae (2002)Source: Park & Bae (2002)

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Reality Check of Regional Bond Market Activities (IV)

Fact 4: Fact 4: Dragon Bonds Issued by Dragon Bonds Issued by Multilateral Financial Multilateral Financial

InstitutionsInstitutions

No Liquidity on the Secondary MarketNo Liquidity on the Secondary Market Very Little Contribution to Bond Market Very Little Contribution to Bond Market

DevelopmentDevelopment

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Reality Check of Regional Bond Market Activities (V)

Fact 5: Fact 5: Tokyo Market Fails to Serve Tokyo Market Fails to Serve Region’s Financing Needs Region’s Financing Needs

Foreign Currency-Denominated Bonds Foreign Currency-Denominated Bonds Virtually Non-ExistentVirtually Non-Existent

Limited Role of the Yen-Denominated Bond Limited Role of the Yen-Denominated Bond Market during the East-Asian Financial Crisis Market during the East-Asian Financial Crisis

Source: Rhee (2003)Source: Rhee (2003)

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Gaisai Bond Market In Japan Unit: ¥ trillionUnit: ¥ trillion

Japanese Japanese Number of Samurai Number of ShogunNumber of Samurai Number of Shogun Fiscal YearFiscal Year IssuesIssues BondsBonds IssuesIssues BondsBonds    19911991 27 27 0.71 0.71 1 1 0.41 0.41 19921992 37 37 1.57 1.57 0 0 0 0 19931993 49 1.23 49 1.23 1 1 0.59 0.59 19941994 60 60 1.26 1.26 0 0 0 0 19951995 85 85 2.11 2.11 0 0 0 0 19961996 154 3.79 154 3.79 0 0 0 0 19971997 66 66 1.58 1.58 0 0 0 0 19981998 10 10 0.15 0.15 0 0 0 0 19991999 24 24 0.87 0.87 0 0 0 0 2000 2000 63 63 2.38 2.38 0 0 0 0 2001 47 1.55 0 02001 47 1.55 0 0 2002 30 0.67 0 02002 30 0.67 0 0 2003 312003 31 0.76 0.76 0 0 0 0

   Source: Japan Securities Dealers AssociationSource: Japan Securities Dealers Association

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Reality Check: Foreign Holdings of US Treasury Securities (VI)

Unit: US $ billion

Economy December 2003

December 2002

December 2001

Japan 545.2 378.1 317.9 China 149.2 118.4 78.6 Hong Kong SAR

57.5 47.5 47.7

Korea 43.4 38.0 32.8 Taipei,China 46.3 37.4 35.3 Singapore 17.7 17.8 20.0 Thailand 11.0 17.2 15.7 Total 870.3 654.4 548.0 Total (Foreign)

1,531.1 1,238.6 1,040.1

Source: Department of the Treasury/Federal Reserve Board Http://www.ustreas.gov/tic/mfh.txt

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Asian

Currency

Figure 1Regional Bond Market

Asian Issuer

AsianInvestor

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Two Major Concerns: On-Going Initiatives for Creation of A Regional Bond Market

1.1. Strong Sense of RegionalismStrong Sense of RegionalismBonds rated by Asian rating agenciesBonds rated by Asian rating agenciesBonds issued by Asian borrowers and purchased Bonds issued by Asian borrowers and purchased

by Asian investorsby Asian investorsBonds traded, cleared, and settled in AsiaBonds traded, cleared, and settled in Asia

2.2. Strong Emphasis on the Public Sector’s RoleStrong Emphasis on the Public Sector’s Role

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As long as Asian borrowers

issue bonds issue bonds at the minimum costat the minimum cost and the and the majority of these bonds are purchased by Asian majority of these bonds are purchased by Asian investors, does it matter?investors, does it matter?

1.1. Where these bonds are issued Where these bonds are issued 2.2. Who rates these bondsWho rates these bonds3.3. Who serves as lead managersWho serves as lead managers4.4. Where these bonds are tradedWhere these bonds are traded5.5. Where they are cleared and settledWhere they are cleared and settled

Extreme Regionalism can be costly and Extreme Regionalism can be costly and counterproductivecounterproductive

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Does It Make Sense?

For the Public Sector to Spearhead:For the Public Sector to Spearhead:1.1. Creation of a regional bond Creation of a regional bond rating rating agency agency 2.2. Creation of a regional clearing Creation of a regional clearing

and and settlement systemsettlement system3.3. Creation of a regional trading Creation of a regional trading

systemsystemHow Do We Coordinate Roles of How Do We Coordinate Roles of Public and Private Sectors?Public and Private Sectors?

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Regional Bond Markets Are Justified for Two Reasons

Two Major FactorsTwo Major Factors

1.1. Asian Common CurrencyAsian Common Currency 2.2. Credit Enhancements for Region’s Credit Enhancements for Region’s

BorrowersBorrowers

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Asian Common Currency

Lessons from EU: Major Benefit of the Lessons from EU: Major Benefit of the Euro for Europe’s Bond Markets Euro for Europe’s Bond Markets

i.i. Elimination of Exchange RiskElimination of Exchange Riskii.ii. Harmonization of Market PracticesHarmonization of Market Practicesiii.iii. Re-denomination of European Government Bonds Re-denomination of European Government Bonds in in Euro…. Euro…. A bigger, deeper, more liquid, and more A bigger, deeper, more liquid, and more

homogeneous European bond homogeneous European bond market market

Full or Partial Currency Unification in the Full or Partial Currency Unification in the RegionRegion : : Coordinated Monetary and Fiscal Policies?Coordinated Monetary and Fiscal Policies?

Regional Efforts are Missing!Regional Efforts are Missing!Asia-Pacific Financial Markets Research Center, University of Hawaii

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Credit Enhancements (I) Taniguchi Proposal (2003): Taniguchi Proposal (2003):

ADB and JBIC serve as credit enhancing ADB and JBIC serve as credit enhancing organizations? organizations?

Asian Bond Fund (ABF) by EMEAP (2003)Asian Bond Fund (ABF) by EMEAP (2003)Useful only for Demand Side of Equation Useful only for Demand Side of Equation but Too Smallbut Too Small

ASEAN+3 Proposal (2003): Asian Basket ASEAN+3 Proposal (2003): Asian Basket Currency (ABC) BondsCurrency (ABC) BondsGood Idea for Supply Side but Operational Good Idea for Supply Side but Operational Framework MissingFramework Missing

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Credit Enhancements (II): Creation of Asian Bond Bank

Modeled After the Municipal Bond Modeled After the Municipal Bond Banks in Canada and the United Banks in Canada and the United StatesStatesSuccessful Examples:Successful Examples:

a.a. Bond Bank of AlaskaBond Bank of Alaskab.b. Municipal Finance Authority of Municipal Finance Authority of

British ColumbiaBritish Columbia Source: Rhee and Stone (2003)Source: Rhee and Stone (2003)

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Asian Bond Bank (I)

Major Benefits of ABBMajor Benefits of ABB1.1. Economies of Scale in borrowing costEconomies of Scale in borrowing cost

2.2. Greater liquidity with larger size bond Greater liquidity with larger size bond issuesissues

3.3. ““Credit rating arbitrageCredit rating arbitrage”:”: ABB re- ABB re-lends funds raised at its higher credit lends funds raised at its higher credit rating to participating Asian borrowersrating to participating Asian borrowers

through structured debt issuancethrough structured debt issuanceAsia-Pacific Financial Markets Research Center, University of Hawaii

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Asian Bond Bank May Implement One or More Credit Enhancing Programs (II)

A.A. Internal EnhancementsInternal Enhancementsa.a. Cash ReservesCash Reservesb.b. Structured Bond Issue:Structured Bond Issue:

Collateralized Bond ObligationsCollateralized Bond Obligationsc.c. Sinking FundsSinking Funds

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Asian Bond Bank (III)

B.B. External EnhancementExternal Enhancementi.i. Third-party Guarantees: Third-party Guarantees:

Multilateral Financial InstitutionsMultilateral Financial Institutionsii.ii. Letters of Credit: Letters of Credit:

Commercial Banks Commercial Banks iii. iii. Bond InsuranceBond Insurance: :

Monoline Municipal Bond Monoline Municipal Bond InsurersInsurers

C.C. Let ABB Bear Foreign Exchange RiskLet ABB Bear Foreign Exchange RiskAsia-Pacific Financial Markets Research Center, University of Hawaii

Thank You!For Further References,

Please visit http://www2.hawaii.edu/~rheesg

Asia-Pacific Financial Markets Research Center, University of Hawaii