Major Currency Debt Markets

Asian investors already buy Asian issuers’ international bonds to a very considerable extent.² Similarly, Asian banks already figure very prominently among the participants in internationally syndicated loans for Asian borrowers. Below, evidence is provided for these generalizations. Their implications should be clear from the outset. The debt markets of Asia could become integrated in one way or another. This integration can occur through the vehicles of the major currencies, principally the US dollar. Or integration can occur in the local currencies of Asia. The increasing flexibility of Asian currencies against the US dollar makes the integration through the US dollar in some ways less risky—borrowers are less likely to suffer the illusion of fixity—and it may make such an evolution less likely. But the head start of the dollar markets is considerable. Thus, in many respects, integration through the major currencies can be considered the default option. That is to say, policy needs to recognize the tendency toward integration in the dollar markets and pursue a coherent and disciplined strategy to steer development in another direction.

A. East Asian Financial Integration in the US Dollar Bond Market

The Republic of Korea's April 1998 $4 billion dollar bond re-opened the global dollar bond market to East Asian issuers after the trauma of downgrades and defaults during the Asian financial crisis. Spreads on dollar bonds issued by East Asian borrowers narrowed over the following years, creating a favorable backdrop to further issuance. With the current account surpluses and corporate financial surpluses of the period since the crisis, however, issuance in the dollar or indeed in the G3 currency markets has not recovered its pre-crisis importance (Schmidt, 2004).

The ample liquidity of the region—whether viewed from the standpoint of surging national official reserves of foreign currency, low loan-to-deposit ratios in banking systems, or generous corporate cash positions—lay behind what came to be known in the market as the “Asian bid” for Asian bonds. This referred to the importance of Asian investors both in the primary market and in the secondary market. While the former can be measured through the reports by underwriters to issuers of the primary placement of bonds, as described below, the latter cannot be measured. Still, its importance was emphasized by market observers like Fernandez and Li (2002), who ascribed the waning sensitivity of Asian bond market prices in 1999–2002 to developments elsewhere in emerging market bond markets to the readiness of Asian investors to take bonds off the hands of global investors at times of strain. This argument implied that the share of Asian dollar-denominated bonds held in the hands of regional investors tended to rise from the level observed in the initial primary market distribution.

Relying on the commentary about new bond issues in trade periodicals FinanceAsia, Asiamoney, and International Financing Review,³ McCauley et al. (2002) measured the Asian share of the initial allocations of bonds issued by Asian borrowers from April 1999 to August 2002. Borrowers from China Hong Kong SAR, Indonesia, Korea, Malaysia, the Philippines, Singapore and Taipei,China were included in the sample. The limitation of this approach was its reliance on second-hand reports from underwriters that are at best approximations and the coverage of which is incomplete.⁴ It is practically impossible to obtain details of every single bond issue. For the issues covered by the periodicals, the share-by-region figures give a broad geographic split among three regions, namely US, Europe, and Asia, where “Asia” generally refers to East Asia including Japan. Bear in mind that these sources provide an indication of only the primary market allocations; as argued above, however, subsequent trading in the secondary market is likely to move more paper into regional portfolios.

Analysis of 71 bonds found that the average Asian share is 46%, while the average weighted share was slightly lower at 44%. By economy, the Asian share ranged from 35% plus in the case of Korea and Singapore to almost 80% in the case of Indonesia (Figure 1 [ PDF 70KB | 1 pages ]). Thus, it was not unusual for the primary market to feature the following succession of events. An Asian issuer chooses an affiliate of a North American or European firm as book runner,⁵ the latter takes the issuer on a roadshow and assembles a syndicate of underwriters, and the underwriters sell about half of the paper to Asian accounts. There are elements of hub and spokes in this scenario, with the funds typically clearing through New York (or in Europe in the case of the euro issues). But at the end of the day, a large portion of the Asian IOUs finds a home in Asian portfolios.

What are the characteristics of Asian issues of dollar or euro bonds that led to a larger or smaller initial regional distribution? McCauley et al. (2002) regressed the Asian share on bond rating, size, and maturity, and on dummies for currency and sovereign issuer. Larger issues and longer maturity issues were placed outside the region to a larger extent. This maturity effect is consistent with the stronger US demand for bonds of ten or more years' maturity, reflecting the importance of pension funds and insurance companies with long- duration liabilities; it is also consistent with the importance among buyers of dollar bonds in Asia of commercial banks and central banks, with their preference for intermediate-term issues. Almost a fifth more of euro-denominated issues were placed outside the region in Europe, reflecting the limited appetite of central banks for relatively illiquid euro-denominated bonds and the limited penetration of the euro in foreign currency bank deposits in the region. The rating or sovereign status had a weak effect on placement.

Given the regional integration observed in the US dollar bond market for Asian issuers, policymakers should recognize the risk of regional integration through the US dollar market. This is the case in North America, where most Canadian corporate bonds are marketed in US dollars to tap the deep and liquid US bond market (McCauley and Park, 2006). In the context of well-developed derivatives markets, such a catering to the US market may well be benign since it need not create currency mismatches for Canadian firms given the ability of the issuers to swap the liability back into Canadian dollars (and the parallel ability of Canadian institutional investors to swap the US dollar asset back into Canadian dollars). In the current state of development of the Asian derivatives market, corporate issuance in the US dollar or other major markets cannot be regarded as posing little risk. In terms of the competition of the dollar markets, Fernandez and Klassen (2006: 133) find its sharpest edge at longer maturities. “Corporate issuance in local currency is heavily skewed to the very short end. For issuance above five years, foreign-currency bonds are favored over local bonds.” Foreign currency issuance also has the edge, albeit a less sharp edge than heretofore, in larger sized offerings: “On average, issue size of local currency issuance is less than half that of foreign currency issuance. It should be noted that, over time… that size gap is narrowing.” These observations suggest that policymakers might give particular weight to improving liquidity in Asian local currency bond markets, particularly at the longer maturities.

B. East Asian Financial Integration in the Internationally Syndicated Loan Market

Ideally, one would like to have a full matrix of banking data for the East Asian economies that one could use to measure the extent of integration of banking markets in the region. Is it true, as has been claimed, that despite the large and growing intra-regional trade, there is no correspondingly large and rapidly growing stock of bank claims, including that associated with the financing of international trade? Unfortunately, the data are not available to the BIS at this point to answer this question fully.⁶ An alternative approach is to examine the participation in internationally syndicated loans. Under normal circumstances, syndicated loans represent something like the flows that correspond to the changes in the underlying stocks of bank loans (Gadanecz and von Kleist, 2002).⁷

Banks from East Asia and the Pacific initially provided 40–80% of funds in internationally syndicated loans to borrowers in East Asia (Figure 2 [ PDF 69.8KB | 1 pages ]). Banks of the same nationality as the borrower typically provided 20% and banks from East Asian economies other than Japan typically provided another 20% of the funds. Japanese banks accounted for another 13% on average.

Evidently, the shift from dollar loans to local currency loans in this market stimulated regional financial integration. Internationally syndicated loans, unlike international bonds, are to a significant extent denominated in regional currencies, with US dollar loans amounting to less than half the total. Loans denominated in local currencies attract more regional participation than dollar loans.

Otherwise, the regional share in loan syndicates suggests the importance of credit standing and liquidity. Loans for borrowers assessed more creditworthy feature greater participation of banks headquartered outside the region, as do larger syndicated loans.

Recently, Gadanecz and McCauley (2006) updated this analysis for the case of the financing of casinos and related hotels in Macao and Singapore. Asian banks tended to account for 30–50% of the funding, notwithstanding the very limited participation of Japanese banks. Asian shares tended to be higher on linked casino-hotel projects, reflecting constraints on certain Asian banks. The share of Asian banks would have been higher were it not for the marketing of one leveraged loan in the United States through a Delaware financing subsidiary to leveraged loan investors, including insurance companies, mutual funds, hedge funds, and collateralized debt obligations.

In sum, the internationally syndicated credit market for Asian borrowers, like the international bond market for Asian issuers, shows a fairly high level of regional integration. Admitted, the evidence for this conclusion is not up-to-date, but there is little reason to think that much has changed in the distribution patterns in these markets. Where the market has been allowed to use regional currencies, in syndicated credits, even higher levels of regional integration are observed. In contrast, domestic currency bond markets, to which we now turn, have remained relatively local.

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