Nothing fires up bankers as does talk of 'the great Asian bond market'. The vast increase in tradeable debt securities that governments and companies are expected to issue is ramping up salaries in the fastest growing area of the regional finance industry. Last year saw European and US banks throw cash at Asian bond and currency trading operations, with guaranteed US$1 million pay cheques making a comeback as banks vied for the small pool of experienced traders and salesmen. All this points to the normal herd mentality of banks when entering new markets, say a growing number of observers. ING Barings' head of territory markets and derivatives trading, Hans de Haan, predicts an imminent shake-out with some of the new entrants exiting the market within a year. 'Many of the new players have no understanding of the settlement, custodian or legal complexities of these markets and will be hurt,' he said. Companies such as Deutche Morgan Grenfell (DMG) have led the way, paying some of the highest professional salaries seen in the region. Others such as Canadian International Bank of Commerce (CIBC), which harbours global ambitions, and Dutch giant ABN Amro have built expensive start-up operations. The new entrants are competing against established names such as Citibank, Hongkong Bank and Standard Chartered Bank, all of which have years of banking relationships allowing them to make better credit assessments of unrated, second-tier borrowers. The US investment banks have built sophisticated trading operations using their technical trading edge and strong client flows from their home market. Some of the most aggressive hiring has been directed at bond and derivative salesmen with ready-made client lists in Korea. Huge salaries have been given to overseas-educated Korean nationals who can deliver 'client relationships' to banks wanting to feed Korean institutions' thirst for high-yield instruments due to high domestic interest rates. In one case, a bond salesman with 18 months' experience in the Korean market was hired from Lehman Brothers to DMG, reportedly for more than US$1 million a year over two years. Across the region, banks are betting that bonds will be issued and bought locally rather than the well-trodden route of US$-Euromarket borrowing. The macro-economic argument for the great Asian bond market is compelling. Until now, the developed capital markets have been the main source of debt funds for Asian corpo-rates. The West and Japan have mature economies which are growing relatively slowly. By contrast, their welfare liabilities from pension and life insurance payouts are on a dramatically steepening curve. High-yielding Asian investment represents a productive use of capital for overstretched pension funds, and promises to save the bacon of actuaries from Boston to Bristol. And yet the growth of Asian economies means that local companies, households, and banks are piling up cash. It is this money pile that is driving the new Asian capital market. Foreign banks bring to the party their expertise in assessing credit, pricing risk and trading the markets. Most Asian companies do not have credit ratings from the major agencies, which means that offshore investors cannot buy their bonds. For this reason, banks such as Peregrine are investing large sums in credit research for unrated borrowers across the region. The kicker for operating in Asian currencies is the huge spreads (the interest premium charged) earned from investing in and trading the markets. Issuers have to pay investors a fat spread to buy their bonds. Banks take on this risk and sell Asian bonds to their off-shore customers. They offer services to domestic issuers and foreign firms investing in Asian projects, such as cross-currency interest rate swaps, for hefty spreads. They sell insurance to those invested in Asian currency assets through currency options, again at a price above that implied by normal pricing models. By managing big positions for off-shore funds, banks have the added advantage of knowing which way the market will move when the deal is executed. This is seen clearly in the interest rate swap market for currencies such as the Malaysian ringgit, Indonesian rupiah and Thai baht where a handful of large deals can move the de-facto yield curve by 100 basis points or more. Arbitrage opportunities also are a sizable source of profit for those smart enough to spot the inevitable mis-pricing that is the result of a limited supply of bonds and illiquid trading. Asset swapping activity - where banks buy a bond that is yielding an above-market return and then swap the fixed return into a floating rate - is popular since corporate bonds trade at widely varying rates. What this means for the banks that have invested heavily in their Asian currency business is a rapid specialisation of roles that only a few years ago were carried out by a handful of multi-purpose traders-salesmen-risk managers. These days, the level of staffing on Asian capital markets desks is much the same as in New York or London. The specialisation of roles has seen Singapore emerge as the centre for trading short-dated paper and spot Asian currencies, while Hong Kong is pre-eminent in dealing longer-dated maturities. And yet, despite the big growth story, there is scepticism that the Asian currency markets offer enough business to satisfy all the new players. That is because much of the profitability from trading Asian currencies over the past five years has stemmed from central bank policies of running strong currency regimes. Indonesia has pegged the rupiah to the US$ (depreciating it at 5 per cent a year) and Thailand has used a basket system to remove the foreign exchange uncertainty of a floating exchange rate. Banks have earned huge profits because current account deficits have been offset by huge inflows of short-term capital stimulated by high interest rates. Holding short US$ against long local currency positions has been a sure-fire trade over the past three years, with the exception of a few shaky moments such as the follow on from the Mexico currency crisis. But with Asian governments waking up to the rip-off, the days of easy money could be over. Thailand has announced its intention to reform its currency basket system and Indonesia possibly will change the rupiah's managed depreciation policy. What that means is uncertainty, which, after all, is what the expensive teams of bankers are hired to deal with in the first place.