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Thursday, 18 April 2019

Paradigm shift

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  • Debt takes over

More Asian firms count overseas capital as an essential source of funding, both for ordinary operations and transformational acquisitions, and the growing number of frequent issuers is bringing greater sophistication to the region’s capital markets.

Ramiro Hinojas, 47, a traffic enforcer, wears a Santa Claus costume as he directs traffic along a main street in Pasay city, metro Manila.

Paradigm shift

Source: REUTERS/Romeo Ranoco

Ramiro Hinojas, 47, a traffic enforcer, wears a Santa Claus costume as he directs traffic along a main street in Pasay city, metro Manila.

As Asia’s capital markets grow and develop, its blue-chip companies are leading the way with jumbo-sized transactions and innovative offerings that are drawing more investors to the region.

Asia may only recently have recovered from the dual setbacks of the global financial crisis and the Asian financial crisis of the late 1990s, but companies increasingly are behaving like players in a maturing market.

“The depth of Asia’s debt capital markets has increased tremendously over the past decade and a half,” said Alexi Chan, head of Asia Pacific debt capital markets at HSBC in Hong Kong.

“The issuer base for G3 bonds has grown to several hundred names from across the region, with China the standout jurisdiction in terms of new names coming to market,” Chan said. “We are seeing both opportunistic moves by issuers to take advantage of favourable issuance conditions, as well as a structural shift in Asia towards the capital markets.”

Debt takes over

Debt takes over

A paradigm shift also appears to be taking place as companies move away from bank financing to rely more on the debt and equity markets. Companies also are increasingly willing to sell more exotic securities and longer-dated bonds, knowing that a market exists to snap them up, although a fully developed high yield market remains elusive.

How much of this shift stems from a global quest for yield in the wake of the US Federal Reserve’s ultra-low interest rate policy is difficult to gauge. The question to that may be answered when US monetary policy returns to normal.

Companies have moved away from loan financing in part because European banks have reined in lending to the region, thanks to the liquidity crunch attributable to the Greek financial crisis, as well as Basel III capital requirements. Those capital requirements are affecting other institutions across the globe and have limited the availability of bank funding.

Banking relationships are still important, though, and the fact they can often lead to mandates for corporate bond deals remains a motivating force for financial institutions. That is, if the price is right.

“The cross-sell remains significant, but the hurdle rate has risen in terms of the overall return banks aim at for extending balance sheet,” said Stephen Williams, HSBC’s head of capital financing, Asia Pacific, in Hong Kong.

“The equation is complex, but ancillary business must be there in most cases for that hurdle to be achieved on a risk-adjusted basis,” Williams said. “On average the hurdle has probably risen around 25bp–100bp for investment-grade corporates.”

Another shift in Asia’s capital markets since the 1990s has been a rise in US investors for a wider array of Asian debt, as well as a burgeoning group of wealthy investors willing and able to buy local and G3 bonds.

“The US bid was, typically, restricted to SEC-registered and 144A bonds, but, with assets under management now growing offshore, US investors are significant players in the Reg S market, too,” said Williams. “This has been coupled with the establishment of offices in Asia. Alongside that, the Asian private-bank bid has continued to drive deals.”

Despite the widening investor base, issuers still call the shots.

“It’s not a case of the tail wagging the dog and, although the bid is there and, in some cases, one or two large investors can change the rules of the game, issuers by and large still drive the primary Asian offshore debt market when it comes to innovation,” he said.

Best issuers

If there were to be contenders for offshore funding leadership among Asia’s corporate titans, the crown would probably go to Hong Kong’s Hutchison Whampoa, given that the Hong Kong conglomerate, either through its own issuance or via holding company Cheung Kong, likes to best its competitors in terms of size. It brought a US$5bn deal in 2003, in Asia’s biggest G3 trade, matched only when China Petrochemical Corp, or Sinopec, sold a US$5bn multi-part offering this April.

In May 2013, Hutchison brought Asia’s first euro-denominated hybrid via a €1.75bn (US$2.3bn) perpetual non-call five Reg S bond using the “staggered” step-up structure, involving coupon increases of 25bp and 75bp at years 10 and 25, respectively. It is a structure that is investor friendly and serves the issuer, given its equity treatment from Standard & Poor’s.

Arguably, this transaction paved the way for Asian issuers to activate the euro market as seen over the past year.

Swire Pacific and CLP Power, also both in Hong Kong, as well as Malaysia’s Petronas, Thailand’s PTT Exploration and Production and the Philippines’ San Miguel Corp also are known for innovation. The Chinese state-owned enterprises are standouts for their size-and-execution savvy, with China National Offshore Oil Corp, or CNOOC, selling a US$4bn bond in late April, the same month as Sinopec’s US$5bn bond.

Much of Asia’s record issuance in the past five years has been dollar-denominated, yet an increasing number of bonds are sold in euros as part of an effort to attract a wider array of investors.

“Interestingly, a manifestation of greater issuance diversification has been the rise of euro paper,” said Herman Van Den Wall Bake, head of debt capital markets Asia Pacific at Deutsche Bank in Singapore. “Some of this has been on the back of M&A-driven activity from Chinese and Hong Kong corporates into Europe, where euro revenue streams have been matched with liabilities.”

“Large Asian corporates are targeting diverse pools of capital across a range of currencies and there’s no doubt that, in our work with borrowers, we are evaluated by what we can offer in terms of currency alternatives.”

The trend can also be put down to cost, with currency swaps running in favour of Asian issuers.

“Given that the basis swap into dollars is negligible, you don’t have to pay up for issuing in euros and swapping back to dollars,” he said. “Euro issuance has gone from nearly nothing from Asia to almost 10% of the total.”

Asia’s large companies also have discovered that they can raise hybrid capital at attractive rates and, although the market is still in the process of working out a favoured structure and appropriate pricing, the hybrid product is, for now at least, here to stay.

“There has been innovation in numerous areas of the Asian debt markets in recent years,” said HSBC’s Chan. “Corporate hybrids are a great example, where we have developed a sophisticated and well-functioning market across G3 and local currencies, with a variety of structures designed to suit the requirements of both rated and unrated names.”

CLP Power and SMC Power, a San Miguel subsidiary, earlier this month gave the Asian perpetual market a shot in the arm with respective US$500m hybrid and US$300m perp non-call 5.5-year offerings. The deals reflect the fact that Asia’s big companies are now eyeing the lowest absolute yield levels seen in the region to capture cheap funding rates before US interest rates rise.

Hybrids are slightly more expensive to sell than senior debt, but they do not affect credit quality or dilute shareholders because rating agencies treat these as equity, but do not count towards ownership.

Both companies used the staggered structure and, in the case of CLP, the issuance was tied to its acquisition last November of a 30% stake in Castle Peak Power and a 51% stake in Hong Kong Pumped Storage Development for a total investment of HK$14bn (US$1.8bn).

As with most of the international corporate debt issuance from the Philippines in recent years, SMC Power’s deal – although meeting generally accepted criteria for blue-chip issuance – was unrated, demonstrating how strong the bid is for a less-than-straightforward credit proposition.

Aside from new structures, companies are expanding the sizes of their offerings in vast multi-tranche transactions. The huge deals test the ability of bankers to price the curve accurately and to sell sizable bond offerings without triggering volatility.

China’s SOEs Sinopec, CNOOC, State Grid Corp of China and China National Petroleum Corp have sold a combined US$14bn in multi-tranche bonds this year in an eye-opening display of market firepower and daring execution.

The deals also underscore how important China has become to global emerging-market issuance, now accounting for about 25% from only 2.5% a decade ago. Also, China Inc’s vast SOEs are increasingly laying down the gauntlet for the region’s blue chips when it comes to approaching new issue structure and execution.

“Execution in Asia has also become highly sophisticated in recent years,” said HSBC’s Chan. “This has enabled the market readily to absorb the significant increase in supply that we have seen.”

Many of China’s issuers have also established access to a variety of offshore bond markets, including the offshore renminbi market in Hong Kong, the Singapore and Australian dollar markets and the G3-currency markets, which gives them more flexibility, according to Chan.

The Dim Sum market has grown exponentially over the past few years, although it is often criticised because most of the offerings only have maturities of three years or less. As the Chinese financial markets move toward liberalising interest rates, bond maturities are expected to lengthen for quality names.

“Large Asian corporates are targeting diverse pools of capital across a range of currencies and there’s no doubt that, in our work with borrowers, we are evaluated by what we can offer in terms of currency alternatives,” said Jake Gearhart, head of Asia Pacific debt syndicate at Deutsche in Singapore.

“A trend over the past few years in Asia among blue chips has been to tap the Reg S market at the expense of the 144A route, [because] documentation is less onerous,” Gearhart said. “Meanwhile, despite question marks about the Chinese economy, there has been a more than 40% increase in issuance from Chinese investment-grade companies year on year.”

Despite this paradigm shift in the borrowing habits of Asia’s large companies, the question remains how the region’s capital markets will respond when US interest rates go up.

It is anyone’s guess whether the mini meltdown in emerging markets, which happened when the Fed first indicated it would scale back on its monetary stimulus, will be repeated, ushering in a period a prolonged morass, or whether it will be managed in a disciplined fashion.

For now, there is no doubting the growing sophistication of Asia’s corporate leaders.

 To see the digital version of this report, please click here.

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