IFR Asia Asian Development Bank Roundtable 2016: Part 2
IFR ASIA: Let’s look at opening up some of the local currency markets. Mr Sriram, there has been a lot going on in the rupee market recently. What is the potential for offshore rupee Masala bonds?
B. SRIRAM, STATE BANK OF INDIA: Masala bonds we’ve started in a very small way. Actually, again the concern for an investor is that it goes from a credit risk into a credit-cum-exchange risk. To that extent, I think the pricing of these bonds plays a very important role in popularising the format.
The advantage of Masala bonds is actually to the corporate that is issuing it. He is clear of the exchange risk there. But to the investor the risk continues to be there, and that’s why the pricing becomes very important.
One of the limitations that we have found is that the Indian banks will not be able to issue these bonds. To a large extent, I think if we are able to free up that space in terms of making the Indian banks able to do that, it will work as a frontrunner to popularise these bonds, because Indian banks’ exposure is very well recognised outside of India.
On the other hand, of course, that while banks can underwrite these bonds, they can’t keep them on their books. I think they have to be sold down within a matter of six months. So, again, the biggest strength in the Indian public sector domain is the banks and the high-rated corporates. I’m sure that they will be able to play a large part in popularising this.
One of the greater advantages of Masala bonds is that it brings to the table a lot of people who’d like to invest in the local currency but today don’t have an opportunity in the offshore markets to play in the rupee.
I think the number of investors would start to improve if we are able to popularise this. It’s a big initiative. I think within the external commercial borrowing space we have now brought in the concept of rupee borrowings, and I’m quite optimistic that we will see a lot of interest in these bonds in the future, as and when the regulations start to improve in favour of the investor.
Of course, the external factors, the macroeconomic factors, and the exchange rate stability would be things the investors would be looking at, and all these play a very significant role in exchange risk management for the investors. I’m sure, as we go ahead, that there will be enough appetite for that.
IFR ASIA: Andrew, back to you: how do you explain how popular the IFC’s issues were in rupees? Then what has been the problem with the corporates?
ANDREW CROSS, IFC: When the IFC first started thinking about Masala bonds, actually the reaction we got, not necessarily amongst investors but amongst arrangers, was “hmmm” – a degree of hesitation, not necessarily convinced about the product. There’d been heavy depreciation in the currency, which was partly, I think, why RBI made the changes that they did.
The first one we issued was actually quite short-dated. Very quickly it picked up momentum, and now there is an IFC Masala curve from three all the way through to 15 years. At the same time, we also started issuing Maharajah bonds, so onshore as well. The two very much tied together.
I think some of the challenges, very candidly, on Masala for local Indian corporates have really been around pricing. The RBI just recently reduced the tenor from five years to three years to make it more of an accessible product. But in looking at some of the roadshows of Indian institutions that have gone overseas, my sense has been that international investors generally have been seeking about 40bp–50bp of additional return, versus what the corporate can issue onshore. When basis points matter, of course you’re going to be finely tuned to that cost. Also the sovereign hasn’t yet issued: I think a sovereign issue would be a very, very welcome development in the growth of the Masala bonds.
So, to your question, I think you had changes at the time two years ago that allowed the initial interest; the instrument got picked up very, very quickly by investors. It’s now broadly accepted. It needs to move from not just the IFIs, but it needs to be onshore corporates that embrace it. Maybe that will be a consequence of single-entity limits just getting to a point where corporates do need to go offshore. The justifiable demand for further infrastructure growth in India again may be the catalyst for seeking capital from offshore. I don’t know if that answers your question; I think I tried to duck part of it.
IFR ASIA: There’s a nice parallel between Masala bonds and the RMB market, where yields very quickly turned much, much tighter offshore than they were onshore. Alexi, what’s the state of play there at the moment? How have you seen the Dim Sum market and the offshore RMB market react?
ALEXI CHAN, HSBC: The opening of the RMB bond market to international players, as part of the internationalisation of the currency, remains a key theme at the moment. It’s important for our audience to be clear that different local-currency bond markets in Asia offer access to offshore investors in somewhat different ways. Masala bonds – and their predecessor in Asia was the global peso note from the Philippines – are essentially synthetic instruments that are settled in dollars but denominated in local currency, thereby providing investors with exposure to the Asian currency on a synthetic basis.
The Dim Sum market is somewhat different; it is actually based on offshore pools of RMB liquidity. As we’ve seen offshore RMB centres grow and develop all around the world, this has supported a vibrant offshore RMB bond market which is both denominated and settled in China’s currency.
We do have a number of examples where both an onshore and on offshore local currency bond market exist alongside each other for a sustained period of time. One example is Australian dollars, where you have the Kangaroo and domestic markets, which are onshore bonds governed by local law, existing alongside an active Euro-Aussie market, in which Australian dollar-denominated securities settle like Eurobonds and are governed by international law.
I’m pretty comfortable with the view that both the onshore and the offshore RMB bond markets will continue to be very relevant to issuers and investors going forward. At the moment, the mechanics of accessing the offshore RMB market are much simpler for international issuers; very similar to issuing in many other currencies off a debt issuance programme.
In the onshore China market, the recent pilot Panda bonds cases have sparked a significant amount of interest globally. We were active in this space with three issuers around the end of last year: HSBC in Hong Kong launched the first Panda bond by a financial institution, followed up very quickly by the Republic of Korea and the Province of British Columbia all coming into the onshore interbank bond market with their own sovereign Panda bonds.
So, we have both options available in RMB for issuers and investors to consider. As you pointed out, the dynamics between the onshore and the offshore markets have moved around significantly. For quite some time, rates were lower in the offshore market and so this represented an attractive option for borrowers, both from China and internationally.
Towards the end of last year, at the time when we brought the new Panda bonds to market, the rate environment had shifted very much in favour of the onshore market, bringing a new dynamic for market participants to consider. In recent weeks, the differential has moderated once again. Over time, as I say, our view is that both onshore and offshore formats of the RMB bond market will continue to flourish.
BRIAN COULTON, FITCH: Maybe I can just add a comment there on RMB internationalisation and the growth of the offshore market. Looking at this as an economist, when countries say they want to engage in capital account liberalisation, the way the Chinese have done it with the offshore RMB and the CNH market is really quite unique. It’s quite a surprising approach that they took, because there was this completely informal market based on the liquidity outside of China, and they actively encouraged its growth.
I kind of worry a little bit that maybe they saw this as kind of a bit of a free lunch with capital account liberalisation, because we all know if you liberalise the capital account, you do give up some degrees of freedom on domestic macroeconomic policy, and there are some potential risks to macro stability. The IMF is writing more and more about that.
I think maybe the Chinese saw this as a way of promoting the global use of the RMB, which they have certainly been very successful in doing. Allowing more of China’s own trade to be invoiced in RMB has been great. It’s obviously helped with the whole SDR debate, but at the end of the day you can’t avoid those trade-offs. If you do engage in some liberalisation, you are going to reduce your degrees of freedom on macro policy. We saw that very much last year when the CNH market moved very sharply, which then fed back to the onshore market because you have players that play in both markets.
How did they react to that? Their decision was a very, very clear one: macro stability way up the top of the list of priorities, rather than the ongoing development of that offshore CNH market. You saw China coming in, intervening in that market, with a massive amount relative to the liquidity in the market, driving interest rates up.
I think at the end of the day they’re going to have to think very hard about carrying on with this liberalisation the way they’ve done it, given that it clearly is leading to constraints in terms of what they can do on the policy side. The reason the gap between the two markets has gone is because now people are worried about the PBoC potentially coming in again.
I’m not sure how much that tells you about how fast they’re going to be in really opening up access to the onshore market, because there are big risks involved. The China hard landing story; why don’t we think that’s going to happen near term? It’s because the loan-to-deposit ratio in the banking system is well below 100%. If they start issuing lots of wholesale funding, getting lots of foreign funding, then that definitely brings an element of risk into the system.
I think China is going to be quite cautious going forward. I don’t think what’s happened to the CNH market, the explosion in the size of that market in the last five years, is a signal at all about how quickly it’s going to go forward; I think they’re going to be pretty gradual from here.
IFR ASIA: Thank you. Let’s throw it open to the floor.
QUESTION: Thank you. Martin Endelman; I’m a retiree from Asian Development Bank. A quick question: throughout Asia we know we have a very large Islamic population, a large amount of finance looking for shariah-compliant investments. Could both the ADB and the World Bank talk about what they’re doing to help develop the Islamic finance market as a source of finance for infrastructure projects, possibly as an issuer, possibly as an investor in those instruments?
MICHAEL JORDAN, ADB: Thank you, Martin, for the question. In ADB’s case in particular, there have been a lot of discussions about it. There are some hurdles internally for us to be funding these types of projects and for us to issue. To be quite honest – and I think, Martin, you probably know about this – we are still grappling with a few internal hurdles. I think some of our other peers have been a lot more aggressive in this than ADB in particular.
ANDREW CROSS, IFC: So, the IFC: in Malaysia in 2004, we did an Islamic transaction; in 2011 we did another one listed in Bahrain and Dubai, so we’re completely open to the idea. Some of the challenges that you experience are, from the first transaction we did in Malaysia to the latter one, some of the rules or the guidance around what would actually qualify as Islamic-compliant changed.
I’d say the biggest change was the fact that both the assets and the use of proceeds had to be Islamic-compliant, whereas when we did the first transaction it was more around the use of proceeds than the underlying assets.
That’s one point; the second point is, if you look at the IFC and the assets that we originate, broadly speaking about 40% are infrastructure, 40% FIG and 20% manufacturing, agriculture, and services. People will forgive the generalisation that is in those numbers.
We don’t do a lot of lending into countries that would typically be generating those assets. If you look at the income levels in those countries, essentially they don’t qualify for the IFC focus and where we would source transactions. Saudi Arabia, for instance: we don’t have an active business sourcing those assets in Saudi Arabia, because the income to GDP generally means that they’re too high. So, the second point is our ability to originate the assets is actually quite challenging at the moment.
The third one is, yes, we’ve done the transactions; we’re open to doing more. We’ve been able to bring them through our internal process, made some changes that were necessary, but really it comes down to the fact that we don’t source enough of these assets to put them into an Islamic-compliant structure.
One last point is sometimes, when you look at Islamic transactions, you need to have quite a careful dialogue with the panel that is opining on whether it’s Islamic-compliant. As you would expect, there sometimes can be differences in interpretational perspective amongst those panels.
IFR ASIA: Broadly speaking, though, the Islamic pool of capital should be ideal for funding infrastructure development, though, shouldn’t it?
ALEXI CHAN, HSBC: Yes, it’s an interesting question. From HSBC’s perspective, we have worked closely with a number of national governments over the years to develop this sector of the market. Back in 2002, we brought the first-ever global sukuk to market, for the government of Malaysia; we also led the inaugural US dollar-denominated sukuk transactions for the Republic of Indonesia in 2009, and for the government of the Hong Kong SAR in 2014.
So, clearly, national governments have been thinking about this issue. In certain jurisdictions, such as Malaysia and Indonesia, this Islamic financing route is aligned with the religious belief of large segments of the population. But in other cases, for example for the Hong Kong SAR, it was more about promoting connectivity between Asia and the Middle East, and facilitating access to a potentially large pool of Islamic liquidity. This concept also fits in well with China’s more recent Belt and Road Initiative.
Coming back to some of today’s other themes, from a local currency perspective, the Malaysian ringgit market is now the deepest Islamic local currency market in the world. Regulators there have taken proactive steps to develop the Islamic segment of the local bond market, to such an extent that this has now become the larger part of the ringgit market.
I think that what’s happened in Malaysian ringgit on the sukuk side could, with the right level of official support, easily occur in other Asian markets too with respect to Green bonds or other similarly important themes.
QUESTION: Hi, my name is Shirish Navlekar, joint managing director and CFO with Mytrah Energy. We are a renewable-focused IPP in India, touching about a gigawatt of capacity now in operation. Such an illustrious panel here, I can’t resist sharing some of my perspectives; it might not exactly be a question, but just sharing some experience and perspective may be, I think, helpful.
We spoke about the Masala bond and talked about the yields. I think IFC has been lucky being Triple A rated; I think they had strong credentials.
About a year and a half back, we attempted doing a high-yield bond from India. It was dollar-denominated – this is much before the Masala bond came into operation. Now we faced a particular challenge, when we spoke about our country. The rating agencies take a very, very conservative view. We get limited by country rating; we get limited by currency risk, and then we get limited by our counterparty risk. In our case, it is all the state utilities, which don’t have that great balance sheets. If we’re talking about a Masala bond, the currency risk is off the table.
What I want to really share with this room is the need for a structural reorientation in terms of when we come to look at some of these things. We are a business with very strong cashflows, so I think if we’re able to look at some of those aspects, I think the accessibility for the Indian corporates to access this market would be significantly better and higher.
The other issue we face is that we don’t have the depth in the domestic debt capital market. I think that is another challenge as far as India is concerned. These are some of the issues which I thought I’ll share with you. I think the rating part, if we are able to look at it, because I think, even if you go for a Masala bond, I think the rating is something which is going to be a constraint. Thank you.
PETER MUNRO, EIB: I’m not sure I can answer the specific question; I just want to make a general observation about credit risk in infrastructure and emerging markets. There is a perception among many investors that this could be a highly risky asset class, but in fact there have been some default studies by one of the major rating agencies, which shows that looking over a very long historical period – there may be a bit of selection bias in the data – it seems that infrastructure in emerging markets is not materially riskier than infrastructure in developed markets.
What we’ve just heard about the situation for an Indian power provider is perhaps representative that there are very strong cashflows. One could look at other markets such as South Africa, where they have a shortage of power supply. The moment one switches on power, there is huge demand for it. So, I think that there may be also, quite apart from the mechanics of ensuring that there’s a credit rating, which is often a critical factor for international investors, there is also, perhaps, a matter of perception which needs to be addressed.
IFR ASIA: Okay. There was another question, I think, over on this side of the room. Yes, sir.
QUESTION: My name is Giuseppe Ballocchi. I used to work in the Investment division of the ADB; now I advise high-net-worth individuals. We heard that one challenge is to match savings with investment opportunities. It seems to me that there are quite interesting investment opportunities coming out of these Asian bond markets. But if one person, one high-net-worth individual, likes to access those directly rather than through funds, in fact the market is not at all efficient. Costs are very high, and if you go through the private bank, you don’t get your money’s worth after you pay all the different fees. That’s very much in contrast to listed markets, where in fact you can get more reasonable access.
IFR ASIA: Okay, how do we address this one, then? Money coming from outside of Asia typically does flow through institutions, doesn’t it? How do we move some of Asia’s markets onto global listing platforms and global settlement regimes?
ANDREW CROSS, IFC: If I look at the work that we all do on local currencies and you run through some of the challenges, so if you’re an international investor and you want to get access to local currency bonds, many of these bonds are not Euroclearable. So, you have to set up clearing and custody arrangements onshore.
Many international investors look at that and they’re not necessarily allergic to it, but they get concerned for a couple of reasons. One is inevitably the friction, the cost. So, to your point: once you start adding more parties into the process, people need to be remunerated for the service they’re providing. Then also for an international investor you’re taking credit risk on the custody.
That typically is one challenge; another challenge can be in some of the countries that we’ve talked about there can be limits on how much of the stock can be owned by international investors and so there can be, let’s call it, ‘quotas’ or ‘limits’. Therefore, when new stock becomes available, it can be competed for very aggressively.
The other aspect with local bonds is they’re typically regulated, as you would expect, under local law. That doesn’t seem to be intuitively challenging when you think about where the assets are, where the currency is, where the business is; that seems to make sense. If you have a dispute, then that would typically be the law that you would be looking to, but for international investors, who are used to a Eurobond with New York or London law, understanding what could be the local situation, especially around bankruptcy and recovery in the case of default, that tends to be very concerning.
None of these are insurmountable; the IFC has done bonds in Rwanda, in Nigeria, in Malaysia, in Costa Rica, in Dominican Republic, in Russia. So, all of these issues are known, and understood, and solvable, but typically most people say, “If you want to quickly and easily attract international capital, then the bonds have to be Euroclearable and, therefore, conform to Luxembourg or Dublin listing standards.”
That’s great if you’re seeking international capital, but what about all the capital in the country that doesn’t necessarily need any of those? To your point, yes, the corporate bond market in India, I think we can all agree, is a little bit thin, does have some issues around credit differentiation. That same thesis is occurring now more in the onshore China market, where you’ve seen a couple of defaults, which have reminded investors that not everything is Triple A. I don’t know if that bought my panellists some time?
ALEXI CHAN, HSBC: I would like to add a few thoughts. It’s an interesting point that’s been raised, in that many people do associate the Asian capital markets with a strong bid from the private banking investor base. I think Andrew’s got it absolutely right: the onshore local currency markets, governed under domestic law, are likely still to be challenging for high-net-worth investors to access. But for the Euroclearable markets – and whether that’s in relation to supply from within the Asian region or from outside of the region – there should be good access for high-net-worth investors through the private banks.
In fact, we see certain types of transactions where the majority of demand can come from private banking investors, and notably from Asia. Perpetual bonds, whether senior or subordinated, issued by corporates or financials, are a good example of this.
From our perspective, this pool of liquidity from Asia high-net-worth investors can be an important driver of certain segments of the business. Steve mentioned earlier around bank capital supply being a key theme in the market, and how Asia has helped fund such capital requirements from various parts of the world. Indeed, Asia has been a source of capital for the West for many years; and while the initial flows were largely through Asian central banks buying US Treasuries and the bonds of other highly-rated official institutions, the more recent flows have seen a wider variety of Asian investors, including private banks, supporting the capital requirements of financial institutions on a global basis.
I think these sorts of dynamics are extremely helpful and go to the heart of today’s discussion topic – the internationalisation of Asia’s bond markets. We can also tie it back to some of the issues we’ve talked around that need to be overcome specifically in the Asian local currency markets, including liquidity and access. The fact, for example, that your clients could get easy access to a wide variety of bonds denominated in, say, offshore RMB and Singapore dollars shows that significant progress has indeed been made in Asia’s local currency markets.
IFR ASIA: Okay. I think we possibly have time for one more question.
QUESTION: My name is Rajeev from Indian Infrastructure Finance Company Limited. I want to know, the message I am getting from here is that Masala bonds are not going to float at anytime soon, so can the panel suggest any specific actions which are required to be taken to make it a success?
B. SRIRAM, STATE BANK OF INDIA: I think it’s a good point. As is already mentioned during the panel discussion, one of the initiatives is to try and get the sovereign to issue those bonds directly, and is to allow the banks to start to issue those bonds to get more appetite, to earn more investor sentiment, and then try and see the corporates get into it.
To your question, actually the issue of getting access to international investors, I think one of the ways – now that the Indian government and also the RBI has enabled us – is in terms of credit enhancement of the bonds. In some way, I think the bankers are in a better position to understand the credit and then enhance it to whatever rate.
If you include the costs of credit enhancement it may not amount to much at the end result, but to some extent I think it should produce some benefit as you go forward. I would imagine then some of the ways and means are to try and build this market and then get the investors’ interest going. Otherwise, I guess if the pricing is where it is today – and it’s a concern – it will take some time for these Masala bonds to pick up.
ANDREW CROSS, IFC: Maybe I can add something. If you cast your mind back two years ago, Masala bonds didn’t exist, so I’m not sure I’m so in line with the opening premise, because I look at how far that market has come in such a short space of time. You have a 15-year curve already in 24 months.
I think the point about pricing is very valid. I think we all in this room know that pricing is not static, so that other point. I think the Masala bonds are another opportunity, another component of a menu of options for providing capital to Indian corporates and the amazing opportunities that are already in India for further expansion and investment in the country.
I understand the sentiment, but for me, when I look already over two years – I look at the changes the RBI has made, I look at the possibility of partial credit guarantees that IFIs and development institutions can provide – my sense would be a much more positive inclination to the further development of Masala bonds.
IFR ASIA: It’s nice to end on a positive note, so with that, please join me in thanking our panel. Thank you all very much for your time.
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