Admittedly, the Christmas season is a time for generosity but not foolhardiness. As such, MAS preserved the existing limits of the development of an offshore market for the SGD, retaining the SGD5 million ($2.88 million) limit on the amount of funds that can be lent offshore. The need to preserve control over it s primary tool of monetary policy - the SGD trade weighted index - therefore delimits MAS s willingness to liberalize.
In almost all other areas, however, the SGD has been internationalized in a move which will add significant depth, liquidity and variety to Singapore s capital markets: non-resident investors can now borrow SGDs to fund local investments, such as the purchase of bonds, equities and commercial property; the repo market has been deepened; asset swapping has been allowed; resident banks can lend SGDs for use overseas, provided the proceeds are swapped into foreign currencies.
The reforms should facilitate a more effective pricing of credit in Singapore s capital markets, and hence help the SGD bond market to grow internationally significant.
The reforms add further strength to our already strong forecast of a continued rally in back-end SGS, of a flattening of the SGS curve, and of a widening of SGD swap spreads.
The SGD becomes more cosmopolitan
These days, Asian researchers often have an urge to cry, bah humbug , in response to any deregulation of economies and of financial markets. The pessimism is borne of disappointment. Everyone remembers the deeply ironic furore that surrounded Indonesia s series of trade liberalization packages prior to the regional financial crisis. Investors grew more optimistic towards the future of the economy and foreign capital poured in every time duties on selected items were trimmed. (As Nero fiddled& ) In Thailand, the optimism that surrounded the opening-up of the financial sector and the creation of an offshore banking market eventually died as the market grew aware that this BIBF facility was the mechanism for funding a bubble. Nevertheless, we are forced to put aside some of our natural scepticism since we are genuinely encouraged by the latest easing of restrictions on the SGD. Regulation 757 the set of rules that restrict SGD internationalization has been altered in a manner that will significantly increase the efficiency of the SGD bond market. They will also throw open some extremely attractive trading opportunities.
The (non) liberalization measure
To tone down the optimism a little, we can start with the disappointment. MAS remains opposed to the development of an offshore SGD market. It has maintained the SGD5 million limit on the amount of SGDs that can be lent to offshore parties for speculative purposes. This may disappoint sections of the market that wished for full internationalization of the SGD. However, we never really believed this likely. In a country whose GDP is under $100 billion, where trade in goods and services are over 250% of GDP, and where 70% of goods consumed locally are imported, Singapore is quite clearly a price-taker in international markets and hence the exchange rate is the most effective mechanism for containing inflation (and managing aggregate demand). We do not expect MAS to fully liberalize the SGD for a while since the authorities are aware this would impede their ability to influence the SGD TWI. For the foreseeable future, therefore, pessimism on the Singapore economy will be best expressed by buying Singapore Government Securities (SGS) rather than by shorting the SGD, and vice versa.
Admittedly, one change to the FX market was the announcement that banks operating in Singapore (local and foreign) can transact SGD options. However, an underlying transaction needs to be associated with a currency option and so the market is for hedging rather than speculative purposes. The restrictions on the development of an offshore SGD market therefore remain intact.
The liberalization measures
While the changes to regulation 757 are initially neutral for the SGD, they have substantial implications for the future of Singapore s fledgling bond market. In essence, they provide the kick-start to the market s development we have been expecting/hoping for. The primary changes are outlined below:
#1 - SGDs can be loaned to non-residents for investment purposes in Singapore.
MAS have said that financial institutions in Singapore can lend SGDs to non-residents to fund investments in SGD assets such as bonds, equities or non-residential property. (The government remains vigilant over the risks of increasing speculative activity and volatility in the residential property market, a sector that has been the bane of many Asian monetary authorities over the years.) This is an extremely significant move that creates the potential for increased demand for underlying SGD assets from overseas entities. (The main increase in demand for SGD assets arising from this reform is likely to come from overseas real money investors rather than banks, which have to apply a 100% risk weighting for Singapore since it is outside the OECD despite its AAA rating.) Moreover, the regulation change allows asset swapping activity in Singapore, meaning that the value of local assets can be judged more accurately in reference to international USD Libor comparisons. The only caveat is that MAS insists that the credit line extended to a non-resident must be withdrawn when the underlying asset is sold. This will prevent institutions from obtaining SGD liquidity by entering into an asset swap and then selling the asset, the mechanism used in 1997 in Thailand to overcome the Bank of Thailand s two-tier USD/THB market.
#2 - Ability to access funding has increased.
MAS has eased its regulations over those entities able to enjoy unrestricted access to SGD funding. All foreign financial institutions in Singapore (such as us) are now classed as resident, whether or not they have full bank licenses. More institutions are therefore able to lend SGDs to investors in SGD assets.
# 3 - Repo facilities have been increased.
MAS has allowed non-resident institutions greater latitude to go short SGD assets via repo. Resident banks can now extend unlimited SGD credit facilities to non-residents via repurchase agreements of SGD-denominated securities, and vice versa. (SGD securities can be lent providing cash of other SGD assets collateralize the transaction.) The ability to short a market is an important stabilizing factor since it helps ensure two-way price action (the SGS tends to be characterized by investors buying or selling, and thus is prone to large, continuous trends). Similarly, the ability to initiate short-positions is key to establishing curve trades, and hence the traditional, excessively steep SGS curve (111 bps spread between 2s and 10s in a country with subdued competition for capital, below trend inflation [and the trend is one of the lowest in the world!] and a 20% of GDP current account surplus) can have better opportunity to flatten.
# 4 - SGD overseas lending.
MAS have allowed non-residents to borrow SGDs for investments outside of Singapore under the proviso that the funds be swapped into foreign currency. To prevent USD/SGD implications, the funds cannot be converted into foreign currency via the spot or forward market. This policy could be a significant medium-term positive for the development of Singapore s capital markets, since so much economic growth within the region is capital constrained: dysfunctional banking systems in Thailand and Indonesia, and a crowding out by government borrowing of private firms from capital markets in the Philippines, suggest that Singapore s liquid banks may provide an interesting avenue for funding activity. However, we do not wish to labour this point. At the end of the day, the appetite among Singapore s banks to descend down the credit curve and lend overseas is unlikely to increase in a hurry, while regional governments are encouraging a deleveraging of local corporate and banking sectors in terms of foreign debt.
# 5 - International SGD bond issuers still need to swap proceeds into foreign currency.
One unchanged ruling is that international issuers of SGD bonds who wish to use the funds outside of Singapore, still have to swap proceeds into a foreign currency. Why highlight this unchanged policy in a section that details reform measures? Quite simply, because the changes made to regulation 757 reduce the significance of this prohibition. Prior to the latest changes, Singapore offered something of a free lunch to overseas issuers of debt. Singapore swap and credit spreads are (for now) extremely tight to SGS, and allowed overseas issuers to raise funds at attractive levels, and the lack of asset swapping activity meant that investors could not compare a company s SGD bond yields with its existing USD bonds for instance. Credit arbitrage therefore increased the frequency of SGD bond issuance by overseas companies, especially of bank sub-debt. Ironically, this credit arbitrage activity was self-reinforcing, since SGD bonds issued that are swapped into foreign currency create receiving interest on the SGD swap curve, and hence overseas issuance of SGD debt acted in the same manner as SGS issuance in terms of tightening spreads. Now, this all changes. An overseas bank or company can issue SGD debt, but it cannot expect the debt to trade at a significant premium to existing non-SGD debt since asset swapping allows USD Libor comparisons and arbitrage. The regulation changes may therefore see an initial fall in the amount of non-resident SGD bond issuance, which will reduce the bias towards tighter spreads. This would be a good thing for the development of Singapore s credit markets if it meant that credit was being priced more appropriately.
What does all this mean for markets?
We expect that the implications of MAS's latest reform measures will be felt over the coming weeks and months. In essence, we expect the liberalization to increase the attraction of our core-underlying trade recommendations in the market (long back-end SGS and paying SGD swaps looking for spreads to widen). But then we would wouldn t we?
- Rally in the quality end of the SGD bond market due to international comparisons: Asset swapping allows for international comparisons of credits. This is likely to spell good news for the top end of the SGD credit market since the current broad compression of spreads and inaccurate pricing of credit, has left the weaker names in Singapore extremely expensive relative to the stronger credits and SGS themselves. This situation should reverse itself. For instance, on a swapped basis, 10-year SGS currently yields 90 bps over the equivalent US Treasuries, for the same level of credit risk (AAA). Additionally, some of Singapore s Agency paper is extremely attractive in USD Libor terms. The HDB 09 (Housing Development Board) is currently flat to USD Libor. HDB s sovereign loss support and thus AAA rating is unequivocal since the statutory board remains a vital component of government policy (the provision of low cost public housing). In contrast, Fannie Mae, where the question of sovereign guarantee and hence the AAA rating is a matter of far greater conjecture, trades at around USD Libor -15. Asset swapping comparisons will therefore support a bid tone to SGS and to some of Singapore s stronger names. In contrast, international comparisons will risk widening spreads on international issuers of Singapore bonds, while some of the more overvalued local credits (let s face it, with a flat SGD swap curve this means most of them) will not benefit from asset swapping. Asset swapping comparisons will therefore support a more effective pricing of credit.
- Increased demand for SGS: On a related point, the fact that MAS has allowed SGD funding for investments, and has expanded the number of financial institutions able to provide this liquidity, should both increase demand for Singapore assets, especially of SGS. As mentioned above, for international real money managers that do not have to be concerned with Singapore s non-OECD provisioning rules, the ability to fund purchases locally will increase the attraction of investing locally. As we have been mentioning for a while, despite a large rally back-end, SGS are still highly attractive buys since the curve is simply too steep and the 230 bps real interest rate spread in the 10-year sector (188 bps in the US) appears highly inappropriate in an economy where the 10-year average CPI is just 1.8% (despite over 7% average GDP growth during this period), and where prices are expected to be below trend in 2001. Interestingly, however, is that a flattening of the curve may be provided with an added kicker by a further reduction in Singapore s extremely high, 18% reserve requirements. This reflects how greater competition in Singapore s capital markets is likely to force the government to cut reserve requirements in a manner that helps support higher profitability and returns on equity. Lower reserve requirements, given the current below-trend levels of competition or capital, would likely see selling interest at the front-end of the curve, but liquidity simply flow down into the mid- to back-end and the free-up liquidity is recycled more into the financial than the real economy.
- Swap spreads to widen: While we are looking for underlying SGS yields to soften, we would expect credit spreads to generally widen, driven first by a steepening and widening of the SGD swap curve. As we have been highlighting, the SGD swap curve is extremely tight to SGS (20 bsp on the 10 year) and offers no trade-off between duration and credit risk. To assume that the swap curve maintains its present shape is to essentially forecast that Singapore s credit markets will not develop any international significance. The recent changes to regulation 757 suggest that the market will develop and that back-end swap spreads will widen. Aside from the fact that the increased international comparatives will support a more efficient pricing of credit, two direct factors will act to widen swap spreads. Firstly, the process of asset swapping will involve paying the SGD swap curve. Secondly, a likely slowdown in non-resident SGD bond issuance (due to an end to credit arbitrage) will reduce receiving interest in the SGD swap curve. The balance of SGD bond issuance into 2001 will therefore change in a manner that will bias spread wider: in the first 10 months of 2000, SGS issuance plus international SGD bond issuance amounted to roughly the same size as local SGD bond issuance (which clearly biased spreads tighter), but into 2001 we would expect a SGD6 billion net increase in SGS, to contrast a $14 billion increase in local SGD bond issuance, and now a SGD2 billion increase in non-resident issuance. (These assumptions are based on recent local SGD issuance trends, on the assumption that MAS will support a more efficient bond market by reducing SGS issuance from this year s SGD10 billion - note the recent buyback operation and that foreign SGD bond issuance will fall from 25% of total corporate bond issuance to levels closer to 10-15%.) This analysis all assumes that swap spreads are clearly a function of the relative supply between government and corporate debt.
Desmond Supple is regional head of credit research for Barclays Capital. Email: [email protected]
