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Thursday, 18 July 2019

IFR Asia Asian Development Bank Roundtable 2016: Part 1

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IFR ASIA: Welcome. Let’s start with a sort of general assessment of how global investors view Asia and Asia’s markets at the moment. I’m going to ask the bankers on the panel to open us up with that.

ALEXI CHAN, HSBC: I think we’ve got a very positive overall picture of investor engagement in the Asian capital markets. In recent years, we’ve seen the size of the Asian bond markets grow quite dramatically, across both US dollars, which is the currency in which a sizeable proportion of the region’s bonds are denominated, as well as individual Asian local currency markets.

There’s been a structural shift amongst the global fixed income investor base, to increase their exposure to the Asian region. Indeed, many of our global clients on the buy side have set up investment offices in Asia, to help manage the increasing proportion of their portfolios that are devoted to the region. This helps in understanding regional developments in greater depth, and is very positive for the development of the Asia’s capital markets.

At the beginning of this year, there was a period of major volatility in the market, based on concerns around movements in emerging market exchange rates, around the oil price, and around the outlook for the Chinese economy. But I think these concerns have mitigated significantly in recent weeks and we’re now seeing risk appetite amongst our client base having returned quite strongly, not only in respect of Asia but across the broader emerging markets universe.

It is important to distinguish between structural and cyclical factors. Cyclical factors will inevitably affect market perceptions, and will ebb and flow. But I think the structural picture is really very positive, reflecting a growing understanding of the long-term importance of the Asian region.

IFR ASIA: Mr Sriram, let’s ask you the same question, then, maybe specifically looking at India, which is one of the fastest-growing countries in Asia now. How have you seen global sentiment change in recent months?

B. SRIRAM, STATE BANK OF INDIA: It’s been pretty positive. Actually, if I can split it into three parts, one is the FDI portfolio flows that have been very robust, and we have been able to see sizeable increases there. The other part is the capital markets, on the equity and the debt side. While the equity markets have also seen a reasonable pick-up, problems remain on the debt side. A lot of policy decisions have been taken around that over the last few months.

Overall, I think the investment climate has been positive. There is a lot of focus on what we call the ‘ease of doing business’. The government has been taking a lot of steps in terms of freeing up FDI, almost in 15 sectors now. The demand for investment into infrastructure especially is significant. I think we are looking at anywhere between US$800bn and US$1trn of investment into infrastructure. Only a small part of it, maybe one-tenth, would probably be financed by government agencies. The rest has to come from other investments, and that’s a very significant portion.

There is a great interest in what we have launched on the smart cities front. It requires investment of almost US$100bn. Again, almost one-seventh or one-eighth will be government-funded, but the remaining will have to be private funded.

These are all opportunities that we have in the country. The important thing is to try and develop that larger investor base, a deeper and broader capital market, and try and get investors to look at Indian risk in a totally different way. We feel that we have good opportunities, sizeable opportunities for investment. As Alexi said, looking at risk differently is something that we would expect for the large, global investors.

IFR ASIA: Brian, I’m going to bring you in on the global economy. How conducive is the backdrop globally for Asia?

BRIAN COULTON, FITCH: The two biggest shocks that have coursed their way through the world economy over the last two years have obviously been the commodity price shock and the slowdown in China’s investment. The second of those is obviously a very big deal for the region. The leverage to China’s property cycle – the property-building cycle – has been very, very high, so that’s clearly been a big issue.

Asia’s exposure to the other shock is obviously good the other way round – the region is generally a net beneficiary of lower commodity prices. But clearly one of the reasons the markets have been breathing a sigh of relief the last couple of months has been the renewed downturn in oil prices and the disinflation that that has again pushed across the world, which has allowed the Fed, certainly Janet Yellen in her March speech anyway, to become quite a bit more dovish than everyone was expecting.

The previous surge in the dollar is clearly a big problem for emerging markets. Our focus here is local markets – the development of local currencies, sovereign, emerging market debt has been a huge success story, but has actually been the biggest victim of the dollar appreciation in terms of the returns investors have been getting in that market.

I don’t think that’s a risk that has gone away. When you look at the relative cyclical position of the US economy, you look at the state of the labour market there, Janet Yellen seems a little bit more dovish than the rest of the Fed. The latest Fed’s minutes were quite different to her speech. Renewed dollar strength is definitely a key risk that we worry about.

When that happens, I think the pressure will come back on the Chinese currency, which has been bailed out because it’s been possible for them to appreciate against the dollar while the basket has actually been weakening. I think that global currency backdrop could be something which upsets markets again, including in Asia.

IFR ASIA: Luke, what can policymakers do about volatility in ASEAN economies?

LUKE HONG, AMRO: Regional markets and regional economies have been experiencing a lot of volatility in the last year, especially in conjunction with China capital market volatility, the Federal Reserve rate hike last December, as well as the January capital market disruption.

In terms of the policies, let me explain it this way: the countries are quite worried about the slow growth in the regional economies. They are trying to use the fiscal policies, but the general revenue collection situation is quite bad at this point, while the expenditure is increasing as they look to support growth. At the same time, monetary policy is also working to promote the growth in an accommodative way.

Country-wise, it is quite different across different countries. Some countries, like Vietnam and the Philippines, are enjoying relatively high growth, while others are severely affected by the low commodity prices. Especially in Brunei and Indonesia, Malaysia, Vietnam, they are severely affected by this commodity price decline overall.

IFR ASIA: Andrew, one of the big initiatives at the moment is to bring more global capital into local currencies. What have you noticed happening recently there, and how is the IFC getting involved?

ANDREW CROSS, IFC: I’d like to make a few comments. If you look at the title, ‘Internationalising Asia’s Capital Markets’, there’s an assumption in that statement that that is a positive. I don’t necessarily believe that all countries in Asia-Pacific fundamentally believe that it is a positive. I think we start in this room with that assumption, but I don’t know that that’s completely owned in the region.

If I look at the developments over the last few years, IFC was involved in the Panda market in 2005-2006; the Asian Development Bank was also in that market. If you fast-forward, we now have an offshore India curve that stretches out to 15 years. If you looked three years ago, that market simply didn’t exist. The IFC’s first issue was three years; now it’s just recently gone out to 15 years.

If you take the premise that, yes, there’s been massive growth in the capital markets of Asia, but when you get a little bit more granular what you basically mean is that there has been significant growth in the Chinese and Indian markets. There’s been very little growth in the corporate bond markets. On the average, it looks great – like Australia’s weather: on average it’s great, as long as you’re comfortable with floods in one region and drought in another. While we’re very committed to local markets, our experience has been mixed.

The other aspect that I would throw in that is that there’s also a presumption that the savings are in the so-called ‘developed’ markets and that there aren’t inherently large pools of local currency savings in the Asian markets. There very clearly are.

Part of the challenge is the way to utilise those savings, because the local currency corporate bond market is very, very thin. You wouldn’t be far off if you looked at pretty much any country in the region and made the assumption that the corporate bond market is 2% to 3% of the total capital market.

You also have a situation in some of the local markets where essentially Double A is investment grade. Fitch will know this very well. It’s true in India, particularly, and you can look at some of the other markets. Double A is investment grade, not Triple B minus.

You have some cultural dynamics. I’m always a bit careful how to pursue that topic, but a lot of businesses in Asia are family-owned. Accepted wisdom would argue against the public disclosure that comes from capital markets borrowing.

The last part, only because I don’t want to monopolise the conversation, is the need for infrastructure. The ADB has already organised some really good seminars here this week where very eloquent and astute people have talked big numbers about the infrastructure gap. Whether it’s US$1trn this year or whether it’s US$5trn, we all accept that there’s a massive infrastructure gap.

The sort of accepted wisdom is that long-term liabilities and long-term assets are going to attract a certain type of investor. That pool of savings wants dollar assets, even though most of the infrastructure probably has a local currency revenue stream rather than a dollar revenue stream. If you really want to close that gap, then you need to have the growth of domestic capital markets.

The challenge with that, though, is that most governments look at their local market as their local ATM. I can’t take credit for that saying, but sovereigns sometimes get quite concerned about the perceived crowding-out effect of letting other issuers into that market and competing for that source of capital.

The other dynamic that I’ve noticed in the region, as one last thought, goes back to my first comment about internationalising. If you think about the Asian FX crisis in 1997-1998, for many policymakers that was a visceral, emotive, deeply profound experience. Many of those people are now the key decision-makers, whether it’s in a regulator, a central bank or a ministry of finance.

There is some genuine pushback to the so-called ‘accepted wisdom’ in favour of free capital flows. I think we just have to acknowledge that and then work with those institutions, with those agencies, with those people to figure out what is the right mechanism. A few thoughts, anyway, just to sort of incite a bit of comment.

IFR ASIA: Plenty of themes there; thank you. Michael, both the IFC and ADB have both been more active in local currencies. What’s the thinking behind that?

MICHAEL JORDAN, ADB: I guess for us in the MDB space, we like to think of ourselves in terms of being a frontier, opening up the capital markets, being able to issue, being able to invest. One of the things that people have to be comfortable with is being able to manage both credit risk and foreign exchange risk.

If IFC, or ADB, or World Bank issues and taps resources, and savings, we take one of the elements, basically, out of the whole equation in terms of credit, given the institution that we are. So, one would hope that over time, especially for infrastructure funding, we can tap into some of these savings to channel to the right places.

IFR ASIA: Okay. What about Asian savings coming into Europe? Peter, are Asian savers a large part of the EIB’s investor base?

PETER MUNRO, EIB: Absolutely, yes. Asian investors are for most issuers, especially those who issue in dollars, an absolutely crucial part of the investor base. The ones that are most prominent are clearly the central banks, but there are also other pools of capital; bank treasuries are becoming increasingly active. We only see that – especially the private capital element – growing over the long term.

In the short term it’s very dependent on what Michael mentioned. I think Asian investors, when they look at foreign credits, are often looking for safer opportunities and going higher up the credit spectrum, but it’s not exclusively so, because we know that they also have an appetite for risk.

One thing that brings a convergence between the development angle and the capital market angle is the idea of taking riskier assets – which could be in Asia or in another transition setting – and giving them some kind of credit enhancement, which also then brings in Western capital into Asia, as well as Asian capital, so it’s commingled.

That’s something we’ve been doing some work on recently, structuring things with either a credit enhancement or some kind of preferential waterfall to encourage private-sector investors to invest in some of the things that are very much needed. Our focus in the region is on climate action. We’re a niche player; we don’t invest a great deal in Asia, we have a limited mandate there, but our specialisation there is to support projects which fight climate change.

We’ve recently, in the past two to three years, made the discovery that, given the right structure, there is actually quite a lot of demand. So far we’ve done equity in a small way, and now that looks like being scaled up to also include a debt slice.

Again, there is this idea that patient public capital takes a bit of a back seat and provides a catalytic effect. We’re seeing a lot of demand from mainstream international investors for emerging-market assets, including Asian assets. Actually, Asia is an area that they’re particularly interested in, as long as they’re comfortable with the quality of the underlying assets – and that’s something we have to work to help them with. As long as they’re confident with that, there should be quite a strong growth in demand, especially in an incredibly low-yield environment in Europe and the US. Even with US rates rising, I think that kind of demand is still very much there.

BRIAN COULTON, FITCH: I’ll just come back on your question about the flows going the other way, Asia savings coming into the West. It’s really been from East to West for quite a long time, actually. We all sit here thinking the debate is the other way round, but it hasn’t been that way for as long as I’ve known it.

We’re potentially at quite an important inflection point in what those flows from Asia to the West are going to look like. Up to now, China’s current account surplus has essentially been recycled by the government into US Treasuries with no credit risk for the Chinese investor – well, not much!

That’s changing. As more external FDI comes out of China, and as the Chinese banks’ external footprint grows, you’re going to see more of that current account surplus, which is not diminishing in any sense. As investment slows down, imports are slowing down with it, so I don’t think China’s slowdown means China’s current account surplus is going to get any smaller; we’ve still got a big savings surplus coming out of China, but it’s going to be channelled by somebody other than the PBoC.

Over time, that is potentially a massive change, particularly for Asia because that’s the first port of call where that money is going to go. What is that going to look like? These are big numbers involved: US$580bn of surplus has got to go somewhere. They’re only at the margins liberalising portfolio flows, but the intention is to do more on that, so it’s banking and external FDI. These are big numbers and this is a different type of investment to what we had before.

IFR ASIA: But you see more of those flows staying within Asia? That’s what you’re saying?

BRIAN COULTON, FITCH: The whole Silk Road ‘One Belt, One Road’ initiative, I think, is a key part of that. It’s sort of a different type of vendor finance, if you like. China was subsidising the US consumer for a long time. That didn’t end so well. I think they’ve seen another potential market for their own exports closer to home, and I think that’s got to be a very important area to watch in terms of saving flows from Asia to the rest of the world.

IFR ASIA: Peter mentioned already the importance of climate change and sustainable investing. How do we get the Green bond market to develop more in Asia? It has seemed to lag a little bit behind what’s been happening in the rest of the world.

ALEXI CHAN, HSBC: Yes, I think that sustainable finance is a topic that’s going to be absolutely critical in the global capital markets going forward. And while Asia was probably a bit slower to get out of the blocks initially than some of the European markets, we’re actually seeing some pretty rapid and encouraging developments now.

Much of the recent progress has been focused around China. Clearly, the opening up of China’s onshore bond markets, as part of the internationalisation of the RMB, is a key theme for market participants, offering opportunities for both issuers and investors to access a vast new market.

The Chinese authorities have given significant focus to developing a major green element to the Chinese bond market. Green bond principles were recently released in China by the PBoC and several other regulatory bodies. With China chairing the G20 this year, this gives an opportunity for this theme of green renminbi bonds to really take off.

Specifically to your question, Steve, there’s been a lot of debate around incentivisation and whether governments can put in place effective measures to incentivise the issuance of such green securities. Our view is that this may be the only way the market will grow to a really significant scale.

If we can get these sorts of incentive schemes right, either in a specific market such as China or more broadly in the international markets, whether that’s through subsidies, tax exemptions, or other regulatory changes, then you could see a wholesale transformation of the market with Green bonds, suitably defined, becoming the dominant class of issuance.

That’s the longer-term vision. And, with environmental concerns being very high up on the policymakers’ agenda in certain Asian countries, we hope to see more rapid progress.

B. SRIRAM, STATE BANK OF INDIA: I just wanted to make one small comment to what Alexi says. The end-use of proceeds for the Green bonds is going into projects in the renewable space, and those are the ones which are high-risk projects.

The viability of the projects is there, and of course the end-use of those funds that is happening. But that is where I think a lot of concern is in terms of how the funds will be raised and employed when there is not much of a distinction between the pricing in a normal bond and a Green bond.

That is where I’ll agree with Alexi that if there are a lot of government concessions by way of taxation and so on and so forth, there will be a big impact on the projects that we are funding. To that extent, the Green bonds will start to gain much more traction.

The demand for infrastructure, of course, is very high, and especially in the green space, but we need to find the ways and means to make sure that the bonds can be priced in a significantly lower way to get that appetite into the Asian markets.

IFR ASIA: Yes. I’m going to bring the multilaterals in, because I think IFC’s bought a lot of Indian Green bonds, haven’t you?

ANDREW CROSS, IFC: We’ve both been an investor and an issuer, so we do have an interest. We have a perspective on this; it won’t surprise you. Back in 2009, I think, we issued our first Green bond, which was a US$200m bond. It was issued about one week after we did a Global bond, and there was a difference in pricing.

At the time, our view was that for an issuer essentially, as Alexi said, we should be incentivised. Green bonds do come with an additional layer of cost around reporting and monitoring – essentially a third-party audit or second pair of eyes – and when we priced the inaugural Green bond we were three basis points tighter than our Global.

That thinking has evolved, and we moved to additionally what contribution could we make to the growth of the Green bond market? The next step, really, was to issue global benchmark-size Green bonds, and we issued a US$1bn Green bond. We took a view that essentially the credit was the same; therefore, the pricing of a Green bond that we would accept was exactly identical to the pricing that we would accept for a Global dollar bond. I don’t know that everybody has that same perspective, but that’s the joy of the market.

If you then fast-forward a few years, we’ve now issued, I think, something like US$5.1bn of Green bonds. The development banks have been very active in this space because it’s clearly a space that we should be active in. We’ve made – the World Bank Group has made – a commitment that 28% of our lending by 2020, which is not that far away, will be in the green space, however you define it.

I think the conversation around Asian Green bonds is absolutely right: you can’t talk about it without talking about China, without talking about the PBoC, which is clearly very committed to this. I think they’ve been very astute in getting different contributions, and I think HSBC, which holds the chairmanship of ICMA at the moment, has had a lot of dialogue around Green bond principles and how that should be becoming more mainstream.

We’re an investor in Green bonds and we’re an issuer. We have a commitment to the space – not just on our loans but on the capital market side. We will be very involved in contributing to how do you define “green”? What are the appropriate reporting mechanisms? What’s the role of a third party or a second pair of eyes in that process? I think EIB has also made a very, very significant contribution to this space, too.

IFR ASIA: Yes. So, just while we’re on this topic, then, my question on Green bonds is always: is there any evidence of additional investment? Does it bring in new investors who otherwise wouldn’t be buying this paper?

MICHAEL JORDAN, ADB: Actually, there’s no doubt about it: the Green bonds are playing a role in all markets because investors are demanding that part of their portfolios are invested in a socially and environmentally responsible manner. This is particularly the case in the developed markets, and it’s becoming more and more relevant here for Asia, especially, as Andrew mentioned, in China.

I think, generally speaking, Green bonds are a response to investor demand. As long as there’s investor demand, there’ll be more and more of these. It’s part of our sustainable drive in moving forward.

PETER MUNRO, EIB: Thanks, Michael. Yes, it’s difficult to add something after my colleagues from the MDBs have pretty much blazed the trail now, but I think maybe I can say a bit more about the thinking from the investor perspective. Our vantage point is that we’ve really heard a lot of praise for IFC for bringing a liquid-size Green bond. We feel that that was a crucial step for the market, so bravo to IFC for this.

I think everyone’s learned from that, and we are also very much engaged now in bringing more liquidity to the market, building a green yield curve. That’s a bit of a novelty for the market, but if we look at it from the investor perspective, they have a number of things they need to figure out. First of all, if they are convinced that climate is a strategic risk and opportunity, which I would say the vast majority of the large and sophisticated investors are now convinced about, the question is how do they apply that in their portfolios? That is less obvious.

Getting the right data about environmental features is difficult. It’s patchy, its meaning is sometimes not so clear; there are different assumptions behind it. Even if they have the data, which is not a given, how do they factor that into their modelling? There are also quite a lot of challenges to be addressed.

What we do see is that investors, while they figure this out, are nonetheless developing some sort of green preference if there is no financial disadvantage in doing so. As we just heard from Andrew, the best practice in the market has really been to price green and traditional bonds on a par with one another, but there is evidence that there are very high levels of oversubscription for some Green bonds, including some of the bonds being issued in Asia. That shows that investors see the potential of this market.

I would also like to return to the interesting points made about the guidance for the market, the governance for the market. One can observe that when the Green bond principles were first introduced in 2014, that triggered a massive expansion of the market. In one year the market almost tripled. We can also see that in China, once there was some clear guidance given to the market by PBoC for the financials, the issuance has grown very, very strongly.

So, it is clear that both the different market participants are looking for guidance here. It is absolutely right that more work is needed to try and provide clearer guidance on what we might call ‘green taxonomies’. Different countries and regions may have different priorities, but we need some categorisation so investors can choose how green they want to be in a particular context.

Those green taxonomies are emerging, but giving investors access to a reliable set of definitions is important. The MDBs have been working together a lot on that – climate finance definitions and so forth – but there will also be other sources. We see that China is giving out a kind of green catalogue with its Green bond market, so we can see that the parts of the ecosystem that are essential to get this to work are beginning to come together. There should be, as we’ve heard from other panellists, a lot of potential for growth because people can see the risks, and they can also see the opportunity.

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