Apec fails to answer Asia bond conundrum
Jake van der Kemp
The push is on once more to start up long-awaited, local-currency bond markets in Asian countries.
The idea, mooted again at the Asia-Pacific Economic Co-operation forum in Malaysia at the weekend, is an attractive one because Asian corporations still have only limited sources of financing.
They can raise equity capital through shares and derivatives (but only if market conditions are favourable), they can go to their local banks or, if they are big and rated, they can go to the US dollar bond market.
But if they had a local currency bond market they would do much better. They would no longer have to rely so heavily on fickle stock markets, they would not be hostage to the off-and-on again tap of local banks and they would not be so greatly at risk to foreigners.
It is also becoming important because Asian insurance and pension businesses are growing and their liabilities are almost all in local currency.
To balance this on the asset side of their balance sheets they would like nothing better than local-currency, fixed-income risk.
Their local-currency assets are much too heavily weighted towards volatile stock markets at the moment.
So it's a good idea and has always been one.
Easier said than done, unfortunately, because there is a big difficulty here called liquidity.
There must be a thriving secondary market in these instruments or they will not succeed.
People who buy them want the assurance that they can sell them again relatively quickly or they will not buy them in the first place.
Good liquidity is also needed to establish price. If trading is thin the spread between bid and offer prices can be so wide that issuers will regard the price as too low, buyers too high and they will both be right.
Liquidity is in some ways more critical on a bond market than on a stock market because all the common shares a company issues are identical but its bonds are not. Each new issue will have different terms.
Several things obstruct liquidity in Asian bond markets, however. The first is that in most successful bond markets, government issues lead the way.
They are the large ones, they carry the least risk and they therefore determine the benchmark yields on which the market trades. The corporate bonds follow.
But, unusual as it may seem following a big financial crisis, Asian governments outside of Japan generally do not have much debt and little of what they have is local currency debt.
They had far more debt 15 years ago in some countries, Malaysia and Thailand particularly, but they have been paying it off or at least keeping it static relative to the size of their economies.
So unless they go needlessly into debt, and massively too, most local currency Asian bond markets would not have that government lead proven essential in other markets.
Secondly, there is the problem of those insurance and pension companies. They would love tradable local-currency debt, love it so much in fact that they would take it all off the market, put it into their vaults and not let it see the light of day again until it matured.
To satisfy this hunger and leave enough in the secondary market to create sufficient liquidity will require big bond markets indeed, bigger than they are likely to be for a long time, and meanwhile the lack of liquidity will hinder their growth.
Thirdly, there is the problem of the dealer network. If a local-currency bond market is to be successful, it must have the depth of large number of experienced dealing teams.
But these are not yet in place in most countries. No-one hires and trains dealers for a bond market that does not exist.
It all comes down to the old chicken or egg question. Which comes first? You won't have liquidity without a lot of bonds and you won't have those bonds without liquidity.
Apec gave the question a lot of talk but no answer yet.