Asia’s dollar bond markets have had a watershed year, with total new issuance up 70% from the whole of last year — surpassing $100 billion for the first time, according to Dealogic.
The story behind this meteoric rise is oft told — rates are at record lows and banks have retreated from loan markets. The Lehman crisis, which saw many banks pulling credit lines, served as a brutal wake-up call for many Asian companies, which are now keen to diversify their funding base away from bank loans.
Year-to-date, total new issuance stands at $120 billion, but, paradoxically, the region’s bond markets have become less liquid. At times, the only way for investors to get hold of a sizeable chunk of bonds has been to participate in a new bond sale (which, in turn, drives new bond issuance).
A big reason for the reduced secondary liquidity is that banks have less appetite to hold an inventory of bonds as they pare down risk assets ahead of stringent Basel III regulations. Across the street, many banks have cut staff on trading desks and are holding fewer bonds on their books.
“I believe that the sell-side trading community now has less budget to trade and keep an inventory of bonds, which has negative implications on day-to-day trading activity,” said Clifford Lau, Asia-Pacific head of fixed income at Threadneedle. “Say we have 10 traders in the market — last year, they might have had an inventory of say $2 billion of bonds to trade and keep on their books. Now, their budget has been cut, which has reduced liquidity.”
The lack of liquidity means that the region’s bond markets are more prone to bouts of volatility, with fire sales when sentiment sours and sharp rises in prices when markets turn bullish.
“We are seeing more swings in the market,” said one syndicate banker. “When the market rallied two months ago and investors wanted to buy bonds, dealers who usually keep an inventory of bonds were short of paper and they were chasing it.”
Another reason for the lack of liquidity is that hedge funds, which account for much of the flows in the market, are less active today compared to pre-Lehman crisis days. Again, this has to do with banks being more cautious — they are less likely to extend the same kind of leverage today.
“Before the 2008 crisis, hedge funds could easily get 10 to 12 times leverage,” said Threadneedle’s Lau. “Now, getting that kind of leverage is almost a thing of the past.”
Meanwhile, according to another syndicate banker, dealers are less aggressive to bid back on bonds when hedge funds put in big sell orders.
The phenomenon is not specific to Asia. Banks are cutting back on risk worldwide. They are re-shaping their businesses to fit the new world order, figuring out which businesses they can stay in and which are profitable.
However, Asia’s bond markets have typically been less liquid than the US market, particularly in the high-yield segment, and the fact that they are becoming less liquid is a problem of sorts. Primary markets may be flourishing, but investors also need a liquid secondary market.
One Hong Kong based fixed-income portfolio manager noted that the lack of liquidity is “something to be mindful of”, and needs to be managed. But he also suggested that the gap is being filled by newcomers.
“We’ve seen a lot of new entrants during the past couple of years — be it Australian, Chinese or Japanese banks looking for market share, to build up their business,” he said. “It might take a bit of time for them to fill the gap. I’m more worried about existing parties and the ability of new parties to take on credit risk.”