Regional Efforts to Encourage Bond Fund Development

Because of awareness of the issues raised above, discussions about regional cooperation in Asia concerning the promotion of local financial markets have been going on for quite a while. However, efforts to promote local bond markets really took off subsequent to the 1997 Asian financial crisis. During this episode, firms experienced disruptions in their balance sheet positions due to currency mismatches following the dramatic exchange rate devaluations suffered by many Asian economies.

Early in the process, it was understood that few of the Asian emerging market economies were prepared to issue bonds in their own currencies. The memory of the 1997 crisis led many countries to fear that excessive holdings of local currency issues by foreign speculators could “… erode control over monetary policy and expose them to currency speculation” (Park and Park 2003). Efforts were therefore launched under a number of regional groups to facilitate the development and depth of Asian financial markets. Most notable among these were the Asian Bond Market Initiative, which sought to develop the infrastructure for the Asian bond markets and to introduce issuance on local currencies, the Chiang Mai Initiative, which sought to mitigate, among other things, the risk of illiquidity through a series of swap arrangements, and the Asian Bond Funds 1 and 2, which sought to increase demand for Asian bonds. The chronology of these initiatives in shown in Table 1 [ PDF 70.5KB | 1 page ], in this section, I review each of them in turn.⁶

Asia Bond Market Initiative and Currency Swaps

In August of 2003, the ASEAN+3 Finance Ministers' Meeting in Manila announced the Asian Bond Market Initiative (ABMI), aimed at improving regional medium and long-term financial conditions. Six voluntary working groups were established to discuss issues relevant to the development of domestic and regional bond markets. These groups examined securitization, credit guarantees, local currency bonds, credit ratings, and foreign exchange transactions.⁷

Regional issuance activity grew in 2004. In June, the Japan Bank for International Cooperation (JBIC, formerly the Export-Import Bank of Japan) guaranteed bahtdenominated bonds issued by Thai firm Tri Petch Isuzu. This was followed at the end of the year by the issuance of “Pan Asian Bonds,” Collateralized Bond Obligations (CBOs), by Japan and Korea. Under this program, senior debt was issued by 46 small- and mediumsized Korean firms with a guarantee from the Industrial Bank of Korea (IBK). Bonds guaranteed by the JBIC backed by these Pan-Asian bonds were then issued on the Singaporean exchange, promoting the creation of a regional collateralized debt obligation (CDO) market.⁸ At the same time, the Asian Development Bank (ADB) and the International Finance Corporation (IFC) issued ringgit-denominated Malaysian bonds.

The progress was codified in the release of the “roadmap” for gathering and sharing information, as well as studies concerning issuing Asian currency basket bonds, regional efforts at promoting liquidity and cross-border trading, and alternatives for tax treatment.

In May of 2008, efforts were increased with the release of the second ABMI roadmap creating task forces for the promotion of issuance and demand for local currency bonds, and improvements in regulatory frameworks and institutional structures. In addition, member countries were asked to develop references for self-assessment to serve as their benchmarks (ASEAN+3 Finance Ministers Meeting 2008).

In addition to the ABMI, the Chiang Mai Initiative (CMI), which was launched in May 2000, set up a network of bilateral swap arrangements among the ASEAN+3 countries. Under these swap arrangements, countries requesting support could immediately access 20% of their facility, while the remaining 80% was to be disbursed under an IMF program. The motivation for linking the disbursement to an IMF program, and hence IMF conditionality restrictions, was to address the region's “… current limited capacity to produce and enforce effective adjustment programs” (Kawai 2007).

3.2 Asia Bond Funds 1 and 2

In June of 2003, the Executives' Meeting of the East Asian and Pacific Central Banks and Monetary Authorities (EMEAP)⁹ announced the creation of the first Asia Bond Fund (ABF1) under the management of the Bank for International Settlements (BIS 2003). The ABF1 consisted of dollar-denominated sovereign and quasi-sovereign Asian bonds equal to approximately US$1 billion issued by the EMEAP countries with the exception of Australia, Japan, and New Zealand. The ABF1 was one vehicle designed to encourage the development of Asian bond markets and reduce the region's perceived excessive reliance on bank financing (Kawai 2005).

From the beginning, it was understood that the ABF1 was aimed at retaining some of the region's reserves within the region in an effort to encourage the development of local capital markets. It was also apparent that true traction in affecting the development of local capital markets would require that the regional fund hold securities denominated in local currencies. It was announced at the outset that such activity was planned for the EMEAP.

With the launch of the second Asia Bond Fund (ABF2), the EMEAP moved toward the inclusion of instruments denominated in local currencies in the Asia Bond Fund. ABF2 invests in local currency issues from EMEAP countries other than Japan, Australia and New Zealand. There are two components of the ABF2, the Pan- Asia Index Fund (PAIF), which invests in sovereign and quasi-sovereign issues from eight EMEAP countries, and the Fund of Bond Funds (FOBF), which invests in eight single market funds that hold sovereign and quasi-sovereign local currency bonds. Both the PAIF and the FOBF have initial allocations equal to US$1 billion (Jang and Hyun 2009).

3.3 Regional credit rating agencies

As discussed above, while successful development of Asian local currency bond markets requires the existence of both regionally specialized rating agencies and rating activity from global firms, many bond issuers in Asia remain uncovered. This reduces the potential investor base for Asian issues, as many large Western institutional agencies such as pension funds, require that the bonds included in their portfolios be rated.

One strategy that is reliant on rating agency coverage is the so-called two-tiered securitization process. Under this procedure, local currency bonds are aggregated into two pools. The senior bonds are sold to an offshore special purpose vehicle, with prices based on their ratings. The special purpose vehicle repackages them and issues asset backed securities. These asset-backed securities are then sold at a price based on their credit rating. Ample coverage and common standards by ratings agencies are therefore required for such transactions to take place.

Efforts have been made to encourage additional coverage by both regional and global agencies. The Association of Credit Rating Agencies in Asia (ACRAA) contains rating agencies from 20 Asian nations that meet regularly to encourage cooperation on rating standards. However, many have called for a regional rating agency (e.g. Park and Rhee [2006]), particularly to encourage ratings coverage of local currency bonds.

Among the firms that are rated by both, there initially seemed to be a systemic discrepancy in the ratings assigned by domestic and international agencies, with those from the international agencies almost invariably being lower. International ratings agencies rate foreign issues for many issuers as simply one notch below the ratings given to the sovereign debt issued in their home country, which themselves are often below investment grade. Large investors – who commonly face restrictions against purchasing securities below investment grade – are often precluded from purchasing these bonds.

There was hope that the ABMI would reduce this gap by “uncovering” creditworthy private borrowers in the region (Park and Park [2003]). This was based on the notion that agencies would be better-informed about the macroeconomic conditions of local economies, as well as firm-specific information about the issuers themselves, and therefore base their ratings less on the ratings earned by the sovereign issues of firms' countries of origin.

Moreover, the quality of ratings was likely to benefit from the existence of deep and viable bond markets within the region. The existence of a deep regional bond base would allow for the creation of regionally specialized rating agencies, which would presumably have superior information concerning the conditions of issuing firms. There would therefore be a feedback to regional bond market development, as the creation of deeper bond markets could enhance the profitability of rating agencies covering such markets, while the greater coverage would encourage more firms to issue in these markets, leading to further deepening.

While the ABMI explicitly called for the development of domestic credit rating agencies in Asia in 2003, the Association of Credit Rating Agencies in Asia (ACRAA) has been acting since 2001 to pursue harmonization of rating standards within the region. However, these efforts are often hampered by differences in legal systems and accounting standards followed across the region, as well as the reality that capital markets across the region are in quite different stages of development (Imai 2004). To address these differences, the ACRAA has created a “best practices” committee which compares the practices of rating agencies across the region. The Asian Development Bank recently issued its Handbook on International Best Practices in Credit Rating (2008), which aims to harmonize and improve standards across the region. There have also been efforts within the region to cooperate in the formation of a ratings agency. For example, in 2006 India, Malaysia, and Indonesia announced efforts to promote a regional ratings agency.

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