Japan Finance Corp for Municipal Enterprises (JFM), a state owned agency that lends to municipal and provincial governments in Japan, yesterday issued a Y20 billion ($190 million) 10 year index linked bond, becoming the first non-sovereign issuer of index linked bonds in the region.
What makes this bond interesting is that as the inflationary environment around the world starts to worsen, so investors are looking for ways to hedge their portfolios. In Japan, as in many countries in Asia, there are few ways of hedging against short term interest rate rises and inflation, says Ayumu Fukuzawa, head of debt capital markets at CSFB in Tokyo. "Although yen interest rates will be staying low, investors are preparing for inflation and this is the right product to protect their portfolios," he says. "This product could be used in the rest of Asia."
The bond carries a redemption formula that sees the bonds pay the 3-month CPI rate prior to the maturity, divided by the CPI rate from September 2004 multiplied by the principal amount. The coupon formula sees the bonds pay the 3-month CPI rate prior to each coupon payment, divided by the 3-month CPI rate in September 2004, multiplied by the amount, multiplied by the notional coupon of 0.47% and then divided by two. The coupons are paid semi-annually in June and December.
This formula is the same as that used for the three outstanding index linked JGB, sovereign bond deals. However, the JFM issue differs in that it also carries a bond floor of 100% of the issue amount. This suggests that the issuer does not expect deflation to return, and it is offering investors a way to increase their returns if inflation starts to rise. JFM has swapped the proceeds into a fixed rate exposure. The bonds were sold to regional, Shinkin and labour banks in Japan. CSFB was sole books.
Given the huge holdings of fixed income instruments by Asian investors, such a product will likely be snapped up, if an issuer can be found. Many banks are undestood to be heavily promoting the product to potential Asian issuers, although none has yet been found. The likelihood of issuance in Asia will be largely dependent on finding the second half of the swap that will allow the issuer to take on a fixed exposure, and not an exposure based on the CPI rate.