When China Cinda Asset Management executed a $1 billion bond deal on February 14, it presented international fund managers with the kind of Valentine’s Day offering they were not keen on receiving, but are sadly suffering on an increasingly regular basis.
On the surface, it did not seem that way.
There was talk that each of the deal’s three tranches had attracted an $8 billion order book.
So did this mean that the enormous syndicate, which encompassed 13 global co-ordinators and 12 lead managers, had tapped into the farthest reaches of their global distribution networks to secure orders?
It seems not. The final deal size ended up being $1 billion which is smaller than previous Cinda deals.
Investors can normally gauge how well a deal has done by its distribution statistics. However, not in this case since syndicate bankers said that none were sent out.
Their absence suggests that much of the order book was either full of supposition, hot air, or led by orders from the lead managers themselves.
Syndicate and non-syndicate bankers alike quickly condemned the issuance process as a chaotic mess. No one was in charge, or accountable, which was hardly surprising given the unwieldy syndicate.
Cinda is an unfortunate but perfect example of all the bad syndicate practices that currently undermine Asia’s G3 bond market based out of Hong Kong.
Michael Dennis, BlackRock’s head of global capital markets in Asia-Pacific, speaks for all his peers in summing up the situation.
“A growing number of bonds are coming to the market at the wrong price and potentially being placed into the wrong hands because of a misguided issuance process,” he said. “A lot of the problems stem from the way the bonds are being issued in the first place.”
In late February, Dennis decided to speak up about the issue at a panel covering bond market practices held by the International Capital Markets Association (ICMA) in Hong Kong. He hoped that his words would not only promote better standards, but also help the Asian G3 market to double in size over the next few years.
Dennis also told FinanceAsia that: “order book disclosure has deteriorated significantly in recent years”. He said that while BlackRock is fundamentally positive on Asian credit opportunities, this lack of transparency is moderating its appetite.
“These concerns about the issuance process mean we see additional risks in the China dollar-denominated primary market compared to the rest of Asia,” he added.
This is not something that Chinese banks, in particular, need to hear just as they are faced with the need to raise billions of dollar to meet their global capital requirements over the next few years. They will need international investors to stick with them.
So too will Chinese corporates faced with re-financing risk and a much smaller Chinese fund management community thanks to the government’s de-leveraging campaign.
The problems centre on Hong Kong: the prime conduit for Chinese issuers raising funds offshore. In essence, too many inexperienced borrowers are being advised by equally inexperienced but highly competitive Chinese banks and brokerage houses, each of them trying to carve out an international name and league table position for themselves.
The situation has been getting worse for some time, but bankers say that it accelerated last year when market conditions deteriorated as well. As issuers, intermediaries and investors came under their worst financial pressure in over a decade, market standards were the first thing out of the door.
And it has not just been Chinese banks and brokerages at fault. A sizeable number of international houses have been keen to defend their market share as well.
Bankers say that standards have unfortunately not improved in tandem with the positive sentiment, which has returned so far this year.
Cinda took advantage of that momentum and its bonds have traded up in line with the wider secondary market. In the short-term, it does not appear to have been penalised for its messy execution. Cinda did not respond to an emailed request for comment.
But many believe it could well lose out over the longer term if market conditions deteriorate. For what no one really knows is where the bonds were allocated and therefore how tightly they are held.
If markets turn, paper could flood back. This would put Cinda’s spreads under pressure and make it far more difficult for it to issue next time around. The fear factor means that Chinese credits are in danger of slipping much more quickly and more deeply than other Asian and global credits.
X DOES NOT MARK THE SPOT
One problem, which Dennis pinpoints, concerns anonymous orders, also known as X orders. Syndicate bankers say that Cinda’s order book was full of them.
Ruari Ewing, senior director of ICMA’s EMEA and Asian bond issuance practice, said that X orders sporadically make an appearance in the wider Eurobond market when certain investors demand absolute confidentiality.
But while they are a rarity in Europe, they have become ubiquitous in Asia. As a result, only the issuer ever knows the full investor roll call.
Syndicate bankers who are supposed to manage a deal and relay the state of the order book to potential investors only have a limited idea of who or what they are dealing with.
Has a competitor deployed an X order to mask the fact that it comes from its own trading desk? Is it trying to gain exclusivity from certain clients, or give favoured clients a second bite of the cherry?
Dennis says that BlackRock is a lot more cautious on deals with a significant proportion of X orders.
He believes that the problem can be solved if intermediaries are incentivised in the same way that they are in the wider Eurobond market. Here fees are fixed upfront and shared among a small group of lead managers responsible for a transparent book building process.
In Hong Kong, however, most lead managers no longer even know what fee they will be paid until a few months after a deal is completed. Chinese borrowers actively pit huge groups of banks against each other and base fees solely on individual order generation.
UNEVEN PLAYING FIELD
In competitive markets, fees always get slashed as banks seek to gain market share. Lower fees are going to be a given at a time when there are so many new Chinese banks and brokers jostling for position with longer-established international banks.
But fund managers like Dennis argue that fee levels ultimately drive banks’ behaviour. “It’s not in an issuer’s interest to set them too low if it wants a good outcome,” he commented.
Those same competitive pressures are also distorting the market in a second way. Undisclosed rebates to certain investors are creating an uneven playing field.
Rebates are most commonly associated with private banking investors, although in 2016 the Monetary Authority of Singapore began to investigate whether they were actually being passed onto end clients.
It has never made its findings public, but bankers say that Singapore-based private banks no longer accept rebates when they place orders.
Big international institutions are unable to accept them on compliance grounds.
A number of Chinese asset managers steer clear of them too. Yang Du, head of asset management at China Securities International Asset Management, said that his institution does not accept them, for example.
But not everyone treads the same path. Bankers say that rebates can tot up to 50 cents on some investment grade deals and reached two percentage points on some high yield deals last year.
That meant that even deals with seemingly generous upfront pricing immediately started to trade below the re-offer in the secondary market.
Why do banks do it? One syndicate head explains: “The Chinese banks and securities house don’t view borrowers from a purely DCM standpoint, but as a much wider relationship. During times of volatility, they view bond offerings as a loss leader.”
“They’ll buy paper at the re-offer in the primary market and then immediately offload big chunks of it to clients at a discount below that,” the banker continued.
One solution would be to try and steer Chinese borrowers to the syndicated loan market where their relationship banks can buy all the paper they want rather than muddying the waters of bond deals, which are supposed to be placed with institutional investors.
Another would be to send out investor updates with much clearer and transparent information about the true state of the order book.
This is not mandatory anywhere in the world. However, both ICMA and the FMSB (FICC Markets Standards Board) have clear principles, which state that pre-pricing book details and post-pricing statistics should be made public.
The FMSB was set up in London after the Global Financial Crisis to create a stronger underpinning for the Eurobond market by putting good conduct and accountability first and forefront. Perhaps it is time for the Hong Kong Monetary Authority to follow the Bank of England's lead and to set up something similar, or nudge Hong Kong-based banks and brokerages to sign up to the FMSB's 10 Core Principles.
For example, Core Principle 8 states that deal statistics should be provided in a standard format and provide an accurate overview of the types and geographical representation of participating investors.
Eeswary Krishnan, Citi’s co-head of Asia Pacific debt capital markets syndicate, suggests that within the Asian context updates should state how much demand the syndicate has at the re-offer price and include orders from joint lead managers.
Chao Li, head of fixed income product at China CITIC Bank International, agrees that this would also help to address the issue of order generation from syndicate banks for their own book.
While acknowledging the problems, Li believes that some market practices have improved during his decade-long stint in the Asian bond markets. “One decade ago, it was never clear how much demand was coming from the lead management group,” he said. “That information is now disclosed.”
Investors also want much stronger Chinese walls between debt capital markets and sales and trading.
When one banker wears both hats, information leakages are more likely. And it is issuers which lose out every time their secondary market trading levels come under pressure because a mandate decision has leaked to the trading desk before it is officially announced to the wider market.
In some respects, Hong Kong’s G3-based bond markets are going through a re-birthing process as Chinese banks and brokerages find their feet. Some Chinese banks are pushing to adhere to best international practices.
China Securities International’s Yang Du, however, believes the process could be speeded up through much better issuer education.
He also argues that the National Development and Reform Commission (NDRC) quota system reinforces the short-term mentality of many Chinese borrowers.
“They’re always in a rush to get their deals out before the quota expires,” he said. “And they face so much pressure from their own boards to explain how they got cheaper pricing than the next guy.”
ICMA’s Ewing agrees. “Issuer education is key,” he said. “I don’t think borrowers fully understand the impact their decisions have on how efficiently a deal will be syndicated, or what the long-term consequences of bad execution might be.”
As Citi’s Krishnan concludes: “The industry needs to re-build confidence in syndicate practices. The bond markets have momentum right now, but investors are more skittish here than other regions because they don’t trust what they’re being told, or what they’re seeing from spread movements.”