Tuesday, 25 June 2019

Debt Capital Markets: Clouds gathering

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Asia’s debt capital markets are facing an uncertain future. Interest rate hikes are on the cards in the US, China’s stock market is in turmoil and the eurozone may be falling apart.

Any one of those events has the potential to destabilise the global fixed income markets, with potentially serious consequences for Asia. Many of the region’s currencies are already under pressure from a rising dollar, and the growing popularity of low-cost overseas debt in recent years has left many companies – and governments – sorely exposed to global capital flows.

The warning signs are well known in Asia, since the regional financial crisis of the late 1990s taught borrowers and policymakers some painful lessons.

While clouds are certainly gathering on the horizon, however, there is one undeniable strength that raises Asia’s chances of weathering any global storm: the Asian investor base.

Asian investors were the driving force behind 2015’s first-half record for G3 currency bond sales. Asian investors also explain how two Chinese companies have managed to issue bonds in euros at the height of the Greek debt crisis, and how Asian banks have had little trouble introducing new, riskier forms of capital securities.

Rising regional wealth also explains how South-East Asian companies have been able to access funding even as their home currencies slide against the dollar – just as they allowed Thai companies to raise money in the midst of last year’s coup.

The rise of the regional investor base since the 2008 crisis has transformed Asia’s debt capital markets.

In particular, Asian private banks are now an established and reliable source of demand for higher-yielding bonds. Rather than living up to their old reputation as ‘fast, dumb money’, high-net-worth investors were discerning enough to shun Singapore oil services companies after last year’s oil price slump, and forced selling as a result of China’s stock market crash was not nearly as dramatic as many had feared.

That’s not to say, however, that the outlook for Asia’s bond markets is entirely risk-free.

Liquidity remains a major challenge. While Asian investors have deep pockets, many of them prefer to buy and hold. That eats away at trading volumes that have already been savaged by the closure of bank prop desks and deep cuts to bank inventory under the pressure of capital regulations.

Thin trading volume raises the risk of sudden and violent price swings, as the prelude to Kaisa Group’s default highlighted earlier this year. It also distorts pricing, since illiquid securities make poor reference points for new issues.

Similar concerns extend to the derivatives markets, which are crucial to allowing Asian issuers and investors to hedge foreign currency exposure or manage interest rate risk. Improving liquidity in the swaps markets would also reduce transaction costs for issuers, but meaningful progress looks unlikely at a time when so many global banks are scaling back their fixed-income trading desks.

Asia’s debt capital markets will need to answer many important questions over the coming months – regardless of when the US starts hiking interest rates. The most important challenge, of course, will be proving that the region remains fundamentally strong in its own right.

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