Back in 1994, when I first moved to Hong Kong, the debt capital markets in Asia excluding Japan were almost non-existent. The only way domestic issuers could raise financing was from the loan market, either domestically or offshore, or in the G3 currencies (US dollar, euro or Japanese yen) for the best of them. The few “bonds” were actually loan-style fixed-rated notes, syndicated primarily to banks.
There were a few reasons behind a dull bond market at that time. First, issuers, either state-owned or family-controlled companies, were reluctant to disclose their financials to be rated, because they were able to get plenty cheap financings from banks. At the same time, the demand was equally shallow. There were very few local institutional investors, and the regional pension and insurance markets were underdeveloped.
The regional market took off after the Asian financial crisis of 1997 that rattled the nerves of government officials and regulators. The crisis exposed how using local currency assets to pay foreign-currency debt can be precarious if the value of local currencies fall sharply over a short period of time.
To address the shortcoming of the financial system, Asian governments started to develop local debt markets, issuing government bonds to develop local yield curves. Other initiatives such as privatisation programmes in China and India also bolstered supply of bond issuances in the local markets, providing commercial opportunities for regional banks to ride on.
Like the old saying suggests: in every crisis lies an opportunity. The Asian local debt market accelerated after the global financial crisis of 2008, driven by a rise in corporate lending. That’s because banks were reluctant to lend due to increasing regulatory scrutiny after the 2008 meltdown. Meanwhile, lenders also found it difficult to borrow cheaply in the US dollar bond market as American investors adopted a broadly “risk-off” bias towards emerging-market debt.
On a brighter note, it was obvious the region withstood the 2008 crisis better than the developed markets, and is on a much stronger footing than it was in 1997. The emergence of a group of Asian-based investors proved that point, and helped feed the rise of the local debt market.
The case of San Miguel Brewery's $800 million-equivalent Philippine peso bond issued early in 2009, entirely placed in the domestic market, demonstrated local DCM markets had developed the depth to successfully fund their biggest and most successful corporations.
On the other hand, China’s political visions also fueled the growth. Beijing’s long-term agenda to reduce reliance on its traditional banking system, and its bid to unseat the US dollar as the dominant reserve currency for central banks are driving the growth of the renminbi-denominated bond markets domestically and internationally.
However, policymakers in Beijing who lived through the 1997 Asian financial crisis may be feeling a queasy sense of deja vu. Problems such as a lack of supply and demand have re-emerged.
To be sure, China's bond market is already the world's third-largest in size, after the US and Japan. But the lack of credit differentiation in the domestic market failed to draw meaningful demand from foreign investors, although Beijing has opened up new channels including Bond Connect to provide more access to cross-border investment flows. New regulations have enabled the emergence of the panda bond market, facilitating access to the Chinese market by foreign investors.
Much remains to be done, in particular in simplifying and harmonising market infrastructure, regulations and enforcement of laws and regulations across the country. Foreign issuers and investors alike need to be able to trust in the rule of law. Market based pricing needs to replace policy-based mechanisms. Technology can be leveraged to help upgrade much of the nuts and bolts of the financial system
China needs a domestic market commensurate to the size and pivotal role in the world economy. Despite the inevitable bumps along the road, it is well on its way to achieving it.
Véronique A. Lafon-Vinais is a seasoned market professional with over 20 years of banking and capital markets experience. She is associate professor of finance in Hong Kong University of Science and Technology, where she teaches MBA, graduate and undergraduate students. Prior to teaching, she worked for Standard Chartered, Credit Agricole and First Chicago (now part of JP Morgan). Veronique is married with two children. She is a French national and a Hong Kong permanent resident.
