How big are BNP's Asian operations?
Asia is the largest footprint outside Europe. It's bigger than both Japan and the US. Taking just the credit markets which I oversee, we've got close to 50 people in primary and secondary markets, distribution and research. Most are based here in Hong Kong, but we've also got a team in Singapore and Sydney and to a lesser extent one or two other regional centres.
In January this year we structurally re-organized our secondary market risk activities. We not only combined our Asian and Japanese trading operations, but also all forms of flow credit products into one business unit. In many cases, a single trader can now trade a different credit in all its forms. This structure has been instituted globally and over time we think it'll give us a price advantage with clients. I talk to my peers in the industry and a lot of firms have moved towards it, but my sense is only at a management level. It hasn't filtered down to the desk level.
Are your operations more geared to distributing European fixed income products into Asia rather than originating and distributing Asian fixed income products into Europe and the States?
Yes, I think that's probably the case. There's unquestionably significant investor appetite for European products here. Partly this is because the supply side of the Asian debt markets is fairly limited.
And you've been a very big player distributing European subordinated debt issues into the Asian retail market, which has grown massively over the last year?
Yes, the retail preference market is a very important one for us. We're currently top of the US dollar league tables and this does give us an ability to talk to investors and issuers on the basis of a market leadership position. The product itself appeals to a lot of financial institutions, which need to re-capitalize themselves, whereas Asia's yield hungry investors like the high nominal coupons.
Why is it Asian investors, which love this product so much? They normally account for about 80% of all demand.
To be frank it's not completely obvious why. But if you look at deal flow over the last six to 12 months, there's been overwhelming Asian demand for all the deals we've been involved in. But Asian investors are quite savvy and consequently can exercise considerable pricing power.
In Europe, the pref share market is more of an institutional one isn't it?
Yes. And maybe in Europe, high net worth accounts already have exposure to these kinds of names through equity holdings, or other forms of debt. I also suspect it's partly to do with the lack of alternatives in Asia, outside of high yield countries like Indonesia. There are very few alternative investments with similar ratings that can offer the same sorts of yield. It's really a yield-driven issue.
Do you think the market will continue to be this hot for the rest of the year?
That's a very interesting question. If you look at the pool of investable savings and the alternatives in terms of yield, then I definitely think there's more demand out there. But what's interesting is that at a certain point, investors will start to look at alternative asset classes again. Four to six weeks ago, the equity markets began to rally after the Iraqi crisis started to subside and some investors said, "right that's it, I'm out of deb". Then when the equity markets consolidated again, suddenly they were all back looking for coupons on pref deals. My own view is that although investors think equity markets are very cheap, there still won't be significant retail or institutional money returning just yet.
What kinds of issuers do you think we're going to see for the rest of this year? Will it be issuers like the UK banks coming back, or new borrowers tapping the market?
If I look at our potential deal flow, then I'd have to say it will be new issuers.
Do you think we'll start to see more international corporates tapping the Asian investor base? Traditionally it's supranationals and financial institutions.
Yes that's right. I've struggled with that question since I moved to Asia about a year ago and the investor feedback I've got is very mixed. I think Asia is somewhat unique in the way that Europe was before the introduction of the euro. That's to say there are several domestic investment pools and the kinds of instruments an investor can buy in Thailand, Singapore, or Korea, for example, is very different. Now that Europe is very homogenous, a lot of corporate bond funds have sprung up.
What's your view on Asian investors desire to buy euro-denominated paper?
In euro, again we're very fortunate to have the number one league table position. But relative to the US dollars, investor appetite for the euro has been fairly limited historically speaking but has recently started to grow substantially. But even though the dollar has been weakening, Asian investors are still imbued with it as the reference currency.
Are you optimistic this will change?
Central bank holdings are moving in favour of the euro currency and there has been re-balancing going on for the last two to three years. Central banks are understandably reluctant to divulge too much about the composition of their holdings. But it's clear it has happened and will continue to do so.
We believe holdings are around 30% compared to 10% to 15% about 18 months ago. But it's a difficult number to pin down and I don't know if they are encouraged to do more now that the euro is at 1.17 than when it was at one.
What about Asian retail? Have they switched into euro too?
That's been somewhat disappointing again. However, appetite from financial institutions and asset managers is growing.
So private client investors that don't play the strengthening euro trade aren't really being rationale?
Well most private clients have more wealth than I have so they're obviously doing something right
But the euro has moved 10% to 15% in the last three months alone, then there's the yield differential…
Yes I agree.
Where do you think the currency will top out against the dollar – 1.25?
The next 12 months.
Yes although it is such a tough call to make as we're now in new territory against the dollar. But if you look at fundamentals and the ECB and Fed policy, it's not obvious that the euro can sustain such strength over the next 12 months. Beyond 1.25, something structural would need to change.
And do you think more Asian borrowers will raise funds in euros?
Let's put this in context. In the last three years, there have only been seven public & syndicated euro-denominated deals from Asia against possibly over 100 in dollars. The key issue is whether an Asian borrower needs euros? There are four possible reasons why - if the price was better than dollars, if they had assets to fund in euros, if they wanted to set a sovereign benchmark, or if they could arbitrage the swap back into some other currency. The fact is that many borrowers have had to pay a premium to dollars and they haven't seen any reason to do so.
What sort of deals are you chasing after? Do you go for the big sovereign mandates, or are you trying to be more selective?
The sovereign business tends to be overbroked and can be unrewarding when you look at the fees sovereigns have been able to negotiate. The risk reward balance doesn't always merit it, although of course we pursue an active dialogue with all borrowers. Our debt capital markets capability is predicated around where we see our strengths.
We've been investing in securitization and looking at bank capital transactions and other higher yielding structures such as CDO's etc.
What's your strategy towards the local currency markets?
In HK dollars, which is probably our benchmark for the region, we've enjoyed top three status for the last five years. Today, for example, we just launched a deal for GECC. In Singapore dollars we're more active on the secondary market side than primary at the moment. The other market where we're beginning to get active is Taiwan. We don't believe the others currently lend themselves to a significant platform in terms of primary markets.
People often say that credit research has minimal value in Asia - because it's all about liquidity and momentum. What's your view?
That's a very intelligent question and one we often debate internally. If you look at Europe or the US, big investors typically have their own research departments and credit research plays a significant role in the distribution side of the business. But when I came here I saw that it's not the case in Asia at all. Investors might buy something because they recognize the name, or they'll buy it once it hits a certain yield level. Its a little frustrating, but it is still possible to differentiate yourself as a trading house with credit views.
Asia also looks like Europe did pre-1999 when it was all about arbitraging FX and interest rate movements. An investor in Korea, maybe more interested in his or her return in Won rather than the credit that's being purchased. In a single currency environment, like Europe, returns are all about credit.