Borrowers and investors in Asian emerging market bonds are increasingly worried about liquidity crunches and flash crashes as markets price in a US rate hike next year.
They noted the reduced role played by banks as lenders and bond traders, due to increased regulatory restrictions, will ratchet up volatility and trap some investors who wish to sell in a rush.
“When you see some of the concentrated positions in some of the names, it is a bit worrying,” said Owen Gallimore, head of credit research for ANZ, at FinanceAsia's Borrowers & Investors Forum held in Singapore on October 30.
Issuers and portfolio managers also warned that many smaller Asian companies are still not adequately hedging their currency exposure, even as they sell bonds denominated in dollars, euros and yen in record numbers.
Such borrowers may be caught out by the strengthening dollar when much of their revenue is generated in local currency.
Damian Glendinning, Lenovo Group’s treasurer, was scathing of companies who left themselves exposed to currency risk: “Corporates and sovereigns who incur substantial currency risk are being irresponsible…It does still happen” despite the harsh experience of currency mismatches that sparked the 1997 Asian financial crisis.
Asian companies have taken advantage of historically cheap debt since the 2008 global financial crisis and demand for yield by global investors to raise capital at a record rate. Emerging market bond funds tripled to $340 billion between 2007 and 2013.
But with the US Federal Reserve having now ended its quantitative easing programme, thanks to a US economy on the mend, international investors are unwinding and reversing that shift of capital eastwards in fits and starts.
The US dollar has appreciated versus all of its 16 major counterparts, touching $112.74 against the yen on November 3 – a seven-year high, according to Bloomberg data.
As a result, portfolio flows to emerging markets slowed to a 2014 low of $1 billion in October, down from $10.5 billion in September, according to the latest EM Portfolio Flows Tracker by the Institute of International Finance.
Larger Asian companies and governments are acutely aware of the dangers of liquidity crunches and currency mismatches as these problems exacerbated the 1997 Asian financial crisis.
Most pundits don’t expect a repeat of last fall’s taper tantrum – but see minor market squalls ahead next year and smaller companies struggling with repayments.
Markets vs banks
Asian companies are more vulnerable to sudden outflows by skittish global investors than ever before given the shift away from bank loans to capital markets in recent years.
Michael Seewald, a managing director at credit rating agency Standard and Poor’s, forecast the risk is only likely to grow. He estimated companies globally have $50 trillion of debt outstanding and Asia represents half of it.
A lot of it is still bank debt, but Seewald estimates if 75% of outstanding borrowing needs to be refinanced in the next five years, banks may not be able to keep up with the demand, meaning more companies will have to tap bond markets instead.
Regulation, such as Basel III capital rules and is also encouraging borrowers to shift from banks to bond markets, said Lenovo’s Glendinning, despite the fact that banks that have maintained longstanding relationships with companies may be steadier counterparties in times of crisis than distant and fickle bond investors.
Marks said he was open to investing in emerging Asia when the opportunities arise but he thinks investments will be more “rifle shot” than large brush.
Bottlenecks
Investors are also concerned that banks’ trading desks are stepping away from providing liquidity in the secondary market as well.
Banks’ prop and dealing desks are less likely to jump into markets as prices drop as their cost of holding positions has risen due to increased capital requirements since the 2008 global financial crisis.
Emerging-market trading as a percentage of outstanding debt has dropped dramatically since 2000, according to the International Institute of Finance.
Investors got a taste of what this means in the Treasury “melt-up” in October when the 10-year bond yield briefly dipped below 2%.
“[The lack of broker-dealer liquidity] has increased the volatility across the board, Treasuries, credit, you name it,” said Tim Jagger, an Asia high-yield portfolio manager at Aviva Investors. The advent of peer-to-peer trading platforms is meant to reduce the impact of lost liquidity, but these remain a work in progress.
Seewald said liquidity bottlenecks are one of the biggest risks facing Asian bond markets once the credit cycle turns. “Refinancing becomes that much more of a difficult task, especially for companies that have leveraged up a lot in order to finance the expansion of their operations,” he said at the conference.
