Can companies turn to domestic bond markets?

As volatility persists across global markets, some Asian issuers are turning towards the local bond market to raise funds. Is this the beginning of a trend?
Over the last few weeks, a few Asian corporates have announced their intentions to raise funds from their local bond markets, rather than the dollar market.

Kia Motors postponed a dollar bond offering in June, and now plans to sell W200 billion ($211.4 million) in domestic bonds, while Hanjin Heavy Industries and Construction said it was tapping the domestic market for $100 million to roll over maturing bonds. In addition, Korean company LS Cable intends to raise $100 million to finance its general operations.

Indonesian telecom operator Mobile 8 also said it was likely to turn to the Indonesian bond market for the $50 million it failed to raise after its dollar offering was downsized last week.

Is it possible, therefore, for other issuers to turn to their home bond markets to raise funds?

There are serious limitations. Despite local Asian markets having achieved substantial size since the Asian crisis, they still remain under-developed.

ôSize matters for liquidity û large markets enjoy higher trading volumes, which in turn underpins narrower bid/ask spreads,ö observes a report released by the Bank of International Settlements (BIS).

And so far only a few Asian markets reach the $100 billion benchmark quoted by BIS researchers as the minimum for a deep and liquid market. These are Korea, which currently boasts a $368 billion market, and China, which stands at $268 billion, according to the 2007 report.

The remaining markets are relatively small, however, with Hong KongÆs currently calculated at $71 billion, followed by India with $56 billion, Malaysia with $54 billion, Thailand with $43 billion and Singapore with $20 billion. Both Indonesia and the Philippines have still smaller markets.

Meanwhile, secondary markets are still relatively illiquid, due primarily to insufficient market infrastructure, poor and untimely information flow and a narrow investor base.

ôPension funds and the bulk of insurance companies are the main elements to local market investor bases, and these tend naturally towards conservative credits. This means that high-yield bonds, or issues from lower-rated companies will not find any buyers,ö says Frank Kwong, head of syndicate at BNP Paribas.

Indeed, most investors across Asia focus primarily on high-quality names. BIS figures show that 40% of MalaysiaÆs market consists of issuers with triple-A ratings equivalent, with another 40% rated double-A equivalent. In Korea, 60% of the market is rated triple-A. Quasi-government issuers, which are most likely to borrow with government guarantees and are thus highly-rated, dominate China and India, and represent more than a third of the market in the Philippines and Indonesia. Meanwhile, financial institutions dominate Hong Kong, Korea and Singapore.

ôIt is a feature of young capital markets that there are not enough investors to replace the demand provided by banks,ö says one source. "Also, some investors may suffer constraints and may be able to buy only a certain percentage of any deal."

In addition, investors may be inexperienced in assessing a credit, and are often constrained by the lack of public information available about a company to adequately price risk.

Moreover, potentially experienced foreign investors, including global intermediaries, are often missing due to withholding taxes and the lack of deep markets for hedging instruments, such as currency swaps. In addition, the fixed cost of obtaining information about issue quality and currency risk limits foreign demand.

The lack of investor diversity within these markets necessarily imposes size limitations on companies wishing to issue large bond offerings. ôMost local markets have yet to develop fully,ö says Mark Leahy, regional head of risk syndicate at Deutsche Bank.

ôThe concept of liquidity provision remains obscure and the development of volume elasticity would be a significant step for local credit markets. If more investors can move from a binary outcome to a scaled price/volume investment philosophy, then these markets would leap forward.

ôIssuers, investors and underwriters are too used to relatively small deals, and it's a leap of faith to contemplate large size offerings because of the price differential that would cause,ö Leahy continues. "But it's a natural - and essential - progression for all markets."

Limitations on tenor are also a major constraint in domestic markets. Banks who hard-underwrite issues are unwilling to do so for longer maturities.

While it is hard to generalise across Asia, size and maturity are the common limiting factors for domestic issuers wishing to tap their home markets. Those forced to turn to domestic markets will compromise to more or less an extent on both of these elements (depending on the market) in order to raise funds.

The notable exception is Korea, which enjoys a large bond market and a well-diversified investor base, but has stringent regulations on who can or cannot tap the offshore bond market. Only highly rated and internationally renowned companies such as Samsung are allowed access to the international markets.

Since these companies already tap domestically, but choose to issue offshore bonds for technical reasons, they will have little trouble turning to their home market to achieve their funding objectives in these volatile times.

However, they will pay a higher borrowing price due to higher interest rates in the region.

Reactions to this state of affairs differ widely. Some bankers are ôhugely disappointedö that the domestic bond markets are still not able to cater to companies seeking to raise substantial, long-term funding in their local currency.

But other bankers are more optimistic: ôTen years on from the Asian financial crisis, domestic issuers can at least tap their home markets to some extent, and continue to function û if not aggressively expand,ö says one source. ôIn 1998, raising funds domestically in Asia was nigh-on impossible.ö
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