The grouping of Asian central banks known as EMEAP, yesterday announced that it had selected nine fund managers and a custodian for the Asian Bond fund 2 (ABF2) initiative, as well as committing $2 billion of seed capital to the funds. The announcement shows the progress that has been made since the ABF2 scheme was revealed in December 2004.
The scheme will see the creation of one Pan Asian Index Fund (PAIF) and eight single market funds. The PAIF will get $1 billion of seed capital and will be managed by State Street Global Advisors (SSgA). It will be domiciled in Singapore and listed in Hong Kong. According to State Street, additional listings in other Asian markets could happen in the future.
The following managers will manage the eight single market funds:
- China Bond Index Fund - China Asset Management
- Hong Kong Bond Index Fund - HSBC Investments
- Indonesia Bond Index Fund - PT Bahana TCW Investment Management
- Korea Bond Index Fund - Samsung Investment Trust Management
- Malaysia Bond Index Fund - AmInvestment Management
- Philippines Bond Index Fund - Bank of the Philippine Islands
- Singapore Bond Index Fund - DBS Asset Management
- Thailand Bond Index Fund - Kasikorn Asset Management
HSBC has been selected as master custodian of the Pan Asian fund and the eight single-market funds. Like the ABF1, the funds will be monitored by the Bank for International Settlements in Basel, but will not be managed by it.
The selection of the individual managers has come after a four-month selection process. Each central bank drew up of list of up to eight potential managers whixh were then invited to submit their proposals. Each central bank along with Mercer Consulting then whittled it down to a short list and then to a winning bidder.
Each fund manager was chosen on the basis of investment capabilities, an implementation plan and the management fees they would charge. EMEAP and the BIS will judge each on how closely their returns match the underlying indices; if there are any large discrepancies, then managers could be changed.
The proportion of the $1 billion seeded into each of the single market funds will be in line with the weightings each country gets in the Pan Asian fund. These weightings have been decided on the basis of the size of the local bond markets, their liquidity and the openness of those markets. The weightings are as follows:
- China - 11.28%
- Hong Kong - 17.05%
- Indonesia - 6.14%
- Korea - 21.26%
- Malaysia - 10.76%
- Philippines - 5.19%
- Singapore - 18.70%
- Thailand - 9.62%
Some markets such as China have a lower weighting than their size would warrant due to the lack of openness in their system.
Both the pan Asian fund and the single market funds will invest in sovereign and quasi-sovereign bonds that make up a new family of indices that were launched yesterday by International Index Company (IIC). This new family of indices will be called iBoxx ABF and covers a universe of almost $1 trillion equivalent of local market bonds.
According to Julia Leung, executive director, external department at the Hong Kong Monetary Authority, IIC was selected as the index provider as it sources the prices for its indices from multiple market providers, not from a single source, which is how the bank indices, such as the HSBC ADBI or JPMorgan EMBI source their prices. This multiple feed system gives the indices better price coverage.
"IIC is particularly pleased to play a key role in this important project to increase the attractiveness of Asian local currency bond markets to international investors," says David Mark, Chief Executive of IIC. "The indices help this goal by providing an excellent basis for investors to understand and follow the market, and they are expected to lead to the development of additional traded fixed income products."
The price providers will initially include AM Bank, Bank Negara Malaysia, Bank of China, China Nation-Interbank Funding Centre, DBS, Deutsche Bank, Hong Kong Monetary Authority, HSBC, Indonesia Inter-Dealer Market Association, Korea Bond Pricing, Monetary Authority of Singapore, Money Market Association of the Philippines, Shanghai Stock Exchange, Standard Chartered Bank, Thai Bond Dealing Centre and UBS. Further price providers will be added in the coming months
Now that the mangers have been selected and the seed money invested, the funds will seek to raise additional money from institutions and the public. The Pan Asian fund will be a listed, open-ended fund in Hong Kong.
The Hong Kong and Singapore funds will be structured as exchange traded funds (ETFs) and will be the first bond ETFs in Asia. The funds in China, Thailand and Malaysia will be listed, while the funds in Korea, Indonesia and the Philippines will not be listed, although Korea retains the option of doing so once it has seen how the fund performs over the counter.
In terms of timing, the funds that are seeking listings all aim to have completed the exercise within a few months. The Pan Asian fund and the Hong Kong fund have already submitted their listing applications in Hong Kong and will list as soon as approvals are granted.
According to Leung, one of the main rationales behind the exercise was to speed up market developments of local currency bond markets in the region. To this end, the move has entailed a number of local market reforms around the region that will enhance the tax and regulatory structures of the markets.
In China, the Pan Asian fund is the first foreign fund that has been given access to the interbank bond market; previously Qualified Foreign Institutional Investors (QFII) could invest in bonds, but only on the much less liquid exchange traded market.
With this move QFIIs will be allowed into the interbank market as well. Also the Chinese central bank has granted the Pan Asian fund special arrangements to get RMB payments of sales and coupons out of the country, representing an opening up of the closed currency system for bond investors.
In Malaysia and Thailand, non-resident investors in local currency bonds can now invest without withholding tax and both countries are changing their regulations to allow the creation of listed bond funds.
The ABF2 has thus been created as a market-led Trojan horse, getting behind the barriers to the region's local bond markets, a task that the private sector would have found hard to do.
"One might wonder why there is a need for the public sector to do this if the... private sector is already there?" says Leung. "We have found that this project provides a vehicle to break down market impediments and the involvement of all the central banks makes this possible."
ABF2 will thus be passively managed, listed where possible and low cost, in order to attract as much liquidity into the funds as possible. The ETFs will work on a system whereby all new money coming in will be used to buy those bonds that comprise the relevant index and these will then be sold as a basket to the ETFs in return for units.
In this way, it is hoped that the NAV of the fund and the price of the ETFs will not get out of synch. If they do it will provide trading opportunities for market players. This system is known as an 'in kind creation and redemption mechanism'.
"This mechanism allows more liquidity into the market and aligns the NAV with the traded price in the ETF," says Leung.
Overall, the new products will certainly add new scope to the market. Depending on their structure, they will also provide trading opportunities for banks that can closely monitor changes in NAV against fund prices. They could even encourage more issuance: if the fund managers are faced with huge demand for the funds, they could ask the relevant issuers to issue more paper. They will also encourage more harmonization in the deregulation of Asia's local bond markets. This can only be a good thing.
"We're introducing a new piece of market infrastructure to Asia," says Leung. "This product will not change the world. But it will play a part in [allowing] different centres to open their bond markets to non-residents and to change their rules. We have produced a cohesive force to make the region's bond markets more liquid and broader."
