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Sunday, 16 June 2019

IFR Asia Reg S Bonds Roundtable 2018: Part 2

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  • Bryan Collins
  • Marc Lewell
  • Alex Lloyd
  • Jessica Gu

IFR ASIA: Probably the cheapest source of money for a lot of issuers in Greater China is going to be bilateral loans or private placements with Chinese banks or Chinese institutions. What’s your take on those?

FRANCIS HO, CLP: Yes, these are very important trends. As China opens up, the banks can do more business in alignment with the central bank’s policy. If the central government promotes a particular kind of industry, then the banks can write large cheques at reasonable terms.

From the perspective of a company based in Hong Kong, which has different sources of income and relationships with multiple parties, we see Chinese banks as more supportive. We tend to believe that by speaking to different parties then probably we can further optimise the terms.

IFR ASIA: I always wonder how sustainable this Reg S phenomenon is, because a lot of this Chinese money may be locked away in two years’ time when policy changes or when the RMB strengthens.

ALEX LLOYD, CLIFFORD CHANCE: You already have that risk, but that’s a very good point. We haven’t mentioned the Chinese regulators, and particularly the NDRC, which can really control the flow of liquidity from China into that dollar market.

It’s slightly unpredictable, as you don’t know whether the regulator is going to open the tap or not. It does also cause some distortions, in particular, because the NDRC essentially regulates longer term paper. You’ve seen a lot of issuance of 364-day paper in a private placement market. Again, I’m not a banker, but I did read ‘Too Big to Fail’ and we all know the risks of funding longer-term obligations with very short-term money.

LORNA GREENE, NAB: Having said that, the main driver for those corporates coming and doing those 364-day issuances is more driven by the quotas that they’re getting from NDRC.

IFR ASIA: Or not getting.

LORNA GREENE, NAB: Exactly. It’s not necessarily that they’ve been rejected or not given a quota, it’s just that they need to fund and it’s taking too long to get those approvals in. So I think they’re being constrained, I don’t think they’re necessarily being irresponsible in choosing to fund short.

ALEX LLOYD, CLIFFORD CHANCE: I think it’s actually an unintended consequence. I don’t think it was necessarily a policy position. The unintended consequence is you have a lot of people who have very short term paper out there, which has a significant refinancing risk that arises the minute you issue.

LORNA GREENE, NAB: The One Belt, One Road policy is going to mean that Chinese companies that are investing overseas are still going to need to raise more funds offshore. The regulator is very aware of this and I think they are less likely to put a stop to Chinese funds moving offshore so that they can support these initiatives.

MARC LEWELL, JP MORGAN: Clearly, we all recognise that if at some point the regulator puts a stop to that investment, it will be disruptive. But it will be disruptive to the Chinese corporate sector first and foremost, and one would imagine the regulators, while caring about the Chinese investor base and the banking system, also care about the issuer base.

IFR ASIA: Jessica, on the execution side, do you find that the growth of Asian money has changed the way that deals are put together? You talked about starting your deals in Asia hours rather than in the US. That’s a significant shift, isn’t it?

JESSICA GU, KEXIM: It is. I guess that’s the current trend that we’re seeing. As Francis mentioned, we’ve been putting ourselves in a position where we need to prepare for the worst times, which will come. In order to minimise refinancing risks for a financial institution, like Kexim, we’ve employed an important strategy of diversifying into different currencies, different groups of investors and different markets. So far, we believe we’ve been quite successful in terms of issuing local currency denominated bonds in 29 different currencies.

We’ve seen some definite changes in the investors that will participate in our deals. Before, our paper used to be sold mainly to asset managers or fund managers mainly in the US. Nowadays, we see more central banks, multilateral banks and all those SSA investors. That’s very encouraging for us.

As a financial institution treasury, that diversification strategy remains one of the most important things that we need to consider whenever we go to market. Yes, we do see a huge shift towards a larger pool of liquidity in Asia, but we have to prepare ourselves for the worst.

IFR ASIA: Does iT create any problems if you start off a deal in Asia and all of your lowest bids come from Asian investors? How do you manage that?

JESSICA GU, KEXIM: I think we need to mention the very latest deal that we’ve done, that was in October. We had to raise US$2bn in US dollars and so that was done in the SEC-registered format. If we were to allocate a lot only to Asian investors we would have been able to achieve much tighter pricing. We opted to offer a single digit new issue concession for a market-friendly, more balanced allocation that was very evenly distributed to investors globally.

We appreciate that our paper has become really popular for Asian investors, especially given that we are eligible for the reserve assets for a lot of investors. We don’t take that for granted, but we still value the importance of diversifying our investor base.

MARC LEWELL, JP MORGAN: Going back to your question about execution and timing and the process, I think you have had two trends going on at once. You had a maturing of the market overall and if you look back 15 years ago every trade took 2 or 3 days and now every trade is done intraday. That isn’t really because the Asia bid has got stronger, per se, it’s because the market’s matured and we’ve gone from having 30 deals a year to 300 deals a year. It’s partly just a matter of becoming a more sophisticated market.

On top of that, the Asia bid being the strongest has meant – I think to Bryan’s point earlier – that more often than not, final guidance on a transaction comes out at 6:00pm Hong Kong rather than midnight Hong Kong time. That part of the trend definitely could reverse if we saw the relative value or relative importance in pricing terms of the US investor base becoming more important again in a different environment.

So if we really felt that the tightest price for Korea Exim was the US investor base, it’s quite likely that we wouldn’t be talking about final guidance until we’ve heard from the US investors, which means until 9:00am or 10:00am New York time, or 10:00pm Hong Kong.

At the moment, for most issuers, we can take a view at 6:00pm, 7:00pm Hong Kong time, because we know based on the last 50 transactions that the US won’t be inside the Asian investor base.

That hasn’t always been the case, it wasn’t even the case two years ago, and so that’s something we’ll obviously need to watch.

ALEX LLOYD, CLIFFORD CHANCE: Speaking of execution, the Reg S market doesn’t require a registered broker deal in the United States – since you’re not making sales within the United States. One of the things that I have seen, in parallel with the growth of the Reg S market, has been the entry of other financial institutions as potential underwriters or financial advisors. That’s partly because in the old days when you had to have a 144A portion that meant you had use a registered broker dealer in the US. It created a natural oligopoly, I suppose. That is being eroded by the fact that you can do the deals without having to go to the US.

IFR ASIA: So what do we think about that? Does it mean a more disjointed execution process? Does it mean issuers aren’t maybe getting the best price for these trades?

FRANCIS HO, CLP: Banks always remind issuers, like CLP, that there can be an optimal number of arrangers or bookrunners. That’s very true, but obviously as corporates, we also look at other factors, like our relationships, and how we can engage with investors in different geographical locations or different sectors.

I would say that it takes greater skill for both the bankers and the corporate to do a deal in the best way. We are all facing this reality. More financial institutions with their base in this region have now come to the market. Since the global crisis, we always heard from banks, whether it’s the top-tier banks, medium-sized or smaller regional banks, that they have the full capability to do this.

MARC LEWELL, JP MORGAN: It’s obviously always going to be self-serving from banks to say, “We should only use two or three banks on a trade.” I’d be interested to hear from Bryan as to what he thinks is optimal. What we’ve always said to issuers is, “We understand you have a lot of obligations because of your other corporate relationships or lending relationships.” Many issuers don’t go to the market very often, and it’s one of relatively few opportunities to reward those relationships.

For best execution, there are diminishing returns beyond three or maybe four lead managers on a transaction. In a strong market with a straightforward transaction, those diminishing returns are relatively mild and one can get away with having 5 or 6 or 27 lead managers. In more challenging transactions or more challenging markets, the danger with having too many lead managers is that everyone is happy for it to be someone else’s responsibility when things aren’t going well. You don’t have the accountability either on the investor side or on the issuer side. When you have three firms on the phone, it’s very clear that those three people are responsible for the trade.

IFR ASIA: This is very much a Reg S, a very much Asia phenomenon. It doesn’t happen in the US, does it?

MARC LEWELL, JP MORGAN: In the US, not so much, because I think lending relationships are less dominant and there are fewer large institutions that are dominant in the US. In Europe it does happen for similar reasons, maybe less frequently than we see in Asia. In Asia it’s clearly got bigger and bigger because, particularly in China, there are lots of institutions that are involved.

I think there is a perception from some issuers that some of these institutions bring in additional demand. Again, it’s self-serving from a global financial institution, but my experience is that there are limited additional orders that really come in that way. People that want to buy a security will come into a security, because it’s out there and everyone knows it’s out there.

From an issuer’s perspective, in recent markets they haven’t seen any downside in adding extra banks. Therefore if they get promised some upside, it’s very understandable for them to add extra lead managers.

If I was an investor I would be more comfortable knowing that the deal was more managed in a more concentrated manner, but Bryan’s probably more qualified to talk about that.

BRYAN COLLINS, FIDELITY: I completely agree with you. There is an optimal number. Too few can be problematic, especially depending on the credit. Too many is typically problematic. The types of leads also matter as well, and there’s a strong correlation with the underlying credit quality as to the number and some of the types that are participating. Also, to be really frank, we’ve got to be mindful of who are the leads. Too many, and the deal can often just be chaotic. Only one just means that others will spite it, which can also have implications.

We look at the lawyer, the auditors and obviously the fundamentals and the pricing, and this all impacts secondary market conviction. If we don’t have that strong conviction that the primary deal is going to be placed well, we don’t buy it. We’ll buy it cheaper in secondary – that’s usually the way it works.

LORNA GREENE, NAB: On the flip side of having what may be perceived as too many leads, if you have too few leads it’s perceived as not liquid enough – and we were consistently getting this feedback from investors over the course of this year. So some investors are actually coming through saying, “We need at least three lead managers, otherwise we can’t participate,” because of the perceived liquidity that it brings.

BRYAN COLLINS, FIDELITY: There is enough evidence of that, especially as you come down the rating spectrum or to less frequent issuers. It’s different if you’ve got a whole curve and it’s different if you’re a very high quality issuer. For those first-time issuers or down the rating spectrum, one is typically too few.

IFR ASIA: I take your point, 27 banks doesn’t necessarily mean a better secondary market. But how much support do you really get from a very small group?

MARC LEWELL, JP MORGAN: Where there’s 27 banks, I don’t think Bryan can legitimately go to any one of those 27 and say, “Guys, this is your trade, it’s got your name on it, you’ve got to look after it.” I think if you’ve got 2 or 3 banks, absolutely, he can have more leverage.

FRANCIS HO, CLP: I recall that close to the global financial crisis, CLP Power had one experience where we worked with a group of banks, perhaps 4 to 5 banks, to do a Reg S bond, very small size. Because of what was happening in Europe and US, we had daily update calls for one month before we could pull the trigger.

That requires perseverance, a very good mind set and the same objective for the whole team working our transaction. I believe that was a good test for both the issuer and the banks, how they could sort out their differences, decide to go or not go, and work out how to get a deal done.

IFR ASIA: When you get into distressed territory, does a Reg S piece of paper give you any less recourse as an investor than a 144A piece of paper?

ALEX LLOYD, CLIFFORD CHANCE: No. Your recourse would be based on what’s in the terms of your instrument. Now I think it’s probably fair to say that the type of investor may be different. If you’re in a distressed situation and you distributed to the 144A market there is a tendency that you’ll have a different type of distressed investor holding your paper. That will have a significant impact on the issuer.

IFR ASIA: Okay, so does a Reg S issue protect you from a US class-action lawsuit, for instance?

ALEX LLOYD, CLIFFORD CHANCE: No. The initial issuance, to the extent that it is not placed in the US, is not subject to the anti-fraud and disclosure provisions of the federal securities laws, but secondary trade in a Reg S security can flow into the US.

When you enter into a distressed situation, the first thing you have to work out is where are your holders. Just because you initially issued it in a Reg S format, doesn’t mean that you’re ring-fenced and you have no US investors. A Reg S issue comes with various holding periods, but as those holding periods expire you can sell into the US to US investors. The Reg S/144A distinction isn’t particularly important in terms of who is the investor base in a distressed situation.

One of the things that does tend to happen is the Reg S market tends to be an English law market, as opposed to the sub-investment grade or high-yield market, which tends to be a New York law environment. That does become important when you go into distressed situations. There are different laws around bondholder meetings, the ability to consent or to exchange, for instance.

I’ve seen it happen, in fact, relatively recently with one large issuer, where a company in distress has a series of bonds out there. Some of them were packaged as Reg S and sold under English law. Some of them were 144A and sold under New York law. That becomes very complicated then because the rights of holders, the duties of trustees and so on, are somewhat different between the two legal regimes.

BRYAN COLLINS, FIDELITY: I completely agree with what you said about the nature of your investor. It obviously depends on the company or the entity as to why it’s in distress and its prospects. That’s going to really drive any restructuring. It might be a spurious correlation, but there are a couple of relatively high-profile cases in just the last year or two where you typically found a speedier resolution – probably even a better resolution – for corporates that have access to both Reg S and 144A, for all the kind of reasons that we’ve been talking about. You’ve potentially got some slightly better quality credit – not necessarily a higher rating, but you’ve probably got a better management team, and a greater willingness to engage with creditors.

IFR ASIA: That’s enough doom and gloom! Jessica and Francis, you both issued Green bonds in the not-too-distant past. Given we’re talking about Reg S and 144A here, does the interest in sustainable investment in the US and Europe change the format question for you?

JESSICA GU, KEXIM: Not really. We’ve done two Green bond issues so far, and I know that we now see Asian investors getting more and more interested in sustainable assets. I guess so far the bonds have been most sought after among US and European investors, but it would be interesting to see how Asian investors adapt to the new investment initiatives around Green bonds going forward.

FRANCIS HO, CLP: We first issued a Green bond for our Indian subsidiary. They did a wind farm, so at the time it was very natural that they borrow from the Green bond market. Then in July this year Capco, the generation company, issued an energy transition bond to support the Hong Kong government’s move from coal to gas generation to further reduce emissions. The group has also facilitated the process by setting up a CLP action financing framework. We call it ‘action’ rather than a Green bond protocol because we believe that we need to take action rather than just having something in black and white.

For the energy transition bonds for the Hong Kong business, we talked to different investors in Hong Kong, Japan, Singapore, Europe, London. We found out that they have very substantial demand even if it’s not Green. We could not do a Green bond because it’s still thermal power, but we worked with the arranging banks to focus more on the ESG – environmental, social and governance – asset managers, who have a separate mandate for this kind of environmental-friendly financing and development work. We saw very good support.

We believe that the US market is important, of course, but for renewable energy, for more sustainable financing, then the potential demand in Japan, Singapore, Hong Kong, Europe, is very strong. I don’t believe there is a strict requirement to go to the 144A market to get a reasonably substantial amount of sustainable financing.

BRYAN COLLINS, FIDELITY: There’s been a significant step-up in ESG investing in Asia, really over just the last couple of years. Prior to that it was more about European investors looking to Asia to add some yield to their ESG mandates. Importantly, we’ve seen that step-up in institutional interest right here in Asia for ESG investing, or low-carbon investing, whatever you want to call it. You can differentiate between different instruments, both for equities and bonds it is more around the ES and/or the G, and that’s how we categorise it in our own internal research.

It’s important to note that debt is debt and that it’s all pari-passu, typically, so you still need to make sure that you’re getting the right price.

With relatively high demand but low supply of Green bonds, it’s been a pretty attractive proposition for issuers and I wouldn’t take issue with that. I think in time we’ll see a bit more capital, and there’ll be more issuance to target that capital, so we’ll probably head back to more of an equilibrium.

MARC LEWELL, JP MORGAN: Overall you still don’t have enough dedicated ESG money to drive a trade on its own. It’s great to see responsible issuers issuing either Green bonds or ESG bonds so that they develop more of a bond pool to encourage investors to dedicate resources to ESG – it becomes a little bit chicken and egg. It’s very important that you have issuers taking their first step to then allow the ultimate asset allocators to put money into ESG portfolios, so that then you get this virtuous circle.

LORNA GREENE, NAB: Of course Green bonds are also bought by investors who are just buying purely because of the credit. So you’ve still got Asian investors who participate in those transactions even though they’re not necessarily buying because it’s green.

Having said that, yes, Asia ex-Japan and ex-Australia has been lagging in terms of the real strong demand for ESG and green assets versus European counterparts in particular, but that is changing. We’ve been seeing that, even just in the last year, there have been a number of new portfolios that have been set up and very large pools of cash that are really focused on this space.

It’s very much driven by governments. When we see the government come in and put initiatives in place it really encourages both issuers and investors to focus more on Green bond issuance, then we see that there’s quite a significant increase in the bid.

I think the more we see governments in the region encourage this type of investing, the more participation we’ll see, and maybe even new dedicated funds being set up.

BRYAN COLLINS, FIDELITY: You can see that actually in the Reg S market. If we focus on issuance from India and China, we’ve seen significant amounts of investment in environmental remediation or renewable energy, which has been government subsidised and government sponsored. It may not necessarily be a Green bond, but it could be financing for an entity which is subsidised through some kind of tariff programme.

That is totally reasonable appropriate kind of ESG oriented investing, whether you’ve got a specific mandate or not. If the underlying credit story happens to tick these boxes, then it probably makes sense for a lot of investors, whether it’s formalised or not.

The key to ESG investing is just how formal your assessments are, and you’ve got all sorts of different ways of doing it. You can draw the line at banks, you can include banks; you can do all sorts of other things. It’s up to the individual investor as to how specific they want to go. It just means you’ve got more choice, which is good.

LORNA GREENE, NAB: The other advantage of buying ESG bonds, but particularly Green bonds, is the framework that is in place and the annual reporting on the use of funds. Investors very much like the transparency these provide and they know exactly where their funds are being invested. So even if they’re not participating because it’s “green”, the transparency that they get as a result of the reporting makes it attractive, too.

IFR ASIA: We’ve talked a lot about the Reg S growth here, but is there really any limit to this trend? I think the biggest deal we’ve had in Reg S so far this year was over US$7bn – is that as big as Asia can ever go?

MARC LEWELL, JP MORGAN: That’s the single largest bank bond in any currency anywhere in the world. I wouldn’t think of it in terms of individual bonds, because I think that deal itself, for Postal Savings Bank of China, highlights a lot of what we’ve been saying – obviously a lot of the core demand for that transaction came from China.

If we think of a lot of Asian economies being somewhat dollarized, at least in their investing mentality, then in some senses when we look at how large can the Asian Reg S dollar market be, it’s a bit like saying, “How large can the US SEC registered market be?” It’s as large a pool as you want, really.

As we’ve discussed across the table, you will see trends where the formats will become more important in certain areas. So 144A might become more important in different market conditions. If we just look at dollar bonds rather than Reg S versus 144A, the Asian market will continue to grow with the Asian economy. One would expect more of the expertise in that bond market to be based in the region. Therefore, more of the decision making will be made in the region and therefore the bond market will become more regional. Even when you have US funds investing in this market, the decision-making in those are based in Asia. That’s another factor that drives some of the process to be more centred on the Asia time zone.

BRYAN COLLINS, FIDELITY: The market can be as big as it wants to be. There’s no limitation on that. The complementary nature of the hard currency and local currency market is obviously a big factor here. It gives us the same access to funding that you might have in the Eurodollar market. That’s probably the closest comparable.

If we’re looking at a broader Asian market, that’s US$14trn-$15trn, including local currency and hard currency, and the hard currency is probably heading towards US$1trn in a couple of years’ time. If you project for the onshore RMB bond market over the next 10, 15 years to mirror the kind of growth that we saw in the US market, when that was in its initial stages of opening up, you’ve got an enormous market in RMB alone. The dollar market will grow along with that as an alternative and supplementary source of funding, particularly for Chinese corporates. We don’t want one or the other; having both is a benefit to sovereigns, to corporates, to financial institutions and to investors.

FRANCIS HO, CLP: I think it’s about how the GDP will grow and how the companies will grow. If China can further open up and liberalise its currency, then I believe that there can be more and faster growth in the regional markets. I would like to issue in RMB, like I can do in other currencies, like the Singapore dollar, Australian dollar, Japanese yen, and be able to swap in any denomination.

ALEX LLOYD, CLIFFORD CHANCE: I also see the range of products available in the market becoming wider, more sophisticated, more structured as the market matures. You’ll start to see everything from more securitisation-type products to more complex mezzanine products and so on. There’s no natural limit, but I think it’s more a broadening rather than a deepening.

IFR ASIA: Lorna, I know you’ve done work on the percentages of Asian issuance that go into 144A. Will that ever go to zero? Will the 144A ever jut become a completely US domestic market?

LORNA GREENE, NAB: No, definitely not. There are number of considerations for an issuer, of course. Obviously, the first thing is the volume, it depends – as Mark touched on before – a lot of regional investors here prefer higher-yielding assets, so they’ve got more of a preference towards Single A, Triple B credits, looking at maybe longer tenors. There’s still always going to be a place for the US investor base, if we are talking about accessing shorter tenors that work very well in the US market. It’s always important to have some diversification of the investor base for an issuer. If there was any dislocation of markets here in Asia, or for some reason Asian investors became not so active, you also want to always be able to still tap into European and US demand. So it’s never going to be the case where the 144A market becomes completely domestic.

IFR ASIA: Ladies and gentlemen, thank you very much for your time.

To see the digital version of this roundtable, please click here

To purchase printed copies or a PDF of this report, please email gloria.balbastro@tr.com

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