The promise of Taiwan's Formosa bonds

A Taiwan bond market roadshow in Singapore forges a link between the islandÆs issuers and foreign investors.
The 2007 Taiwan Bond Market Roadshow, organised by GreTai in Singapore on June 26 at the Shangri La Hotel, proved a great success, with a large number of buy-side investors and investment banks eager to learn about developments in Taiwan.

An expert panel of speakers had been assembled to inform the audience and take questions at the end of the half-day, afternoon session. These comprised: Daung-Yen Lu, chairman of GreTai Securities Market; Dr Edward Chow, supervisor, GreTai Securities Market and Dean at the college of commerce at National Chengchi University; Dr Shyan-Yuan Lee, commissioner of the Financial Supervisory Commission of the executive yuan of the Taiwan government; Philip Tsao, president of the China Development Industrial Bank; Mr Michael Yong, president of the Financial Markets Group, Fubon Financial Holding; and Mr Frank Kwong, MD and head of syndicate, Asia, for BNP Paribas. Replacing Richard Grainger, director and head of financial institutions debt capital markets of Barclays Capital, was Gilbert Wong, from the same department of Barclays Capital.

The first speaker was Daung Yen-Lu of GreTai Securities Market, which is the government-designated organisation with a mission to promote and supervise TaiwanÆs stock and over-the-counter fixed income market. Established in November 1994, GreTai is dedicated to service excellence and equipped with an advanced trading system, which enables GreTai to provide a dynamic capital market offering stocks, bonds and derivatives trading.

Taiwan is one of the most dynamic economies in the region. Its government is keen to match the prosperous economy with a thriving capital market. The conference in Singapore was an opportunity to discuss what developments have recently occurred in Taiwan with regard to the bond markets and in what way they might appeal to investors.

ôThe most important goal of the Taiwan fixed income market is to not get left behind in the race between bond markets in Asia,ö pointed out Shyan-Yuan Lee of the FSC in Taiwan in his presentation.

There are grounds for optimism, since the US dollar amount of bonds outstanding is now $160 billion, up from just $60 billion in 2002. And bond trading volumes reached $7.5 billion last year û compared to just half a billion in 2000. Also since that year, outright trading has surpassed repo trading û implying that dedicated traders are now looking for money-making opportunities, as opposed to bonds being lent overnight as collateral for a quick loan. But both in terms of issuance and in terms of trading, the market is dominated by government bonds û of the $5.2 billion traded in 2006, $5 billion came from trading government bonds, and of the $160 billion outstanding, $90 billion is from government bonds.

According to Commissioner Lee, in 2009, Taiwan will implement new tax structures on interest income for all fixed income products. Under the proposals, individuals and mutual funds will be taxed at 10% separately from their other income, regardless of whether it is outright ownership or repo (since previously for repo there was no tax for individuals and mutual funds). Similarly, for companies, regardless of outright ownership or repo, interest income will be taxed together with other income at 25%. Commissioner Lee predicts that this policy change will have a significant impact on the bills market, the securitization market, and the money market fund market.

In the derivatives space, Commissioner Lee pointed out that, based on the trading volumes of 10-year government bond futures, the market was developing û essentially, on the back of reforms carried out by the regulators. Indeed, previously 10-year bond futures saw minuscule trading volumes because of the need for physical delivery and tax issues.

The burning issue for investors at the conference was undoubtedly the tax issue, in particular the 20% withholding tax which foreign investors have to pay if they cash out their bond position. Many questions were directed at the panel of specialists about this matter û but while many were optimistic about this issue eventually being sorted out, the political nature of the question made it extremely hard to get a precise timetable on the matter.

A notable recent development within Taiwan is the æFormosa bondÆ, which was discussed by Frank Kwong of BNP Paribas, Hong Kong. BNP underwrote the first-ever Formosa bond, which the company described as a non-NTD denominated bond issued by Taiwan domestic or foreign entity with a credit rating of BBB or higher, and from a listed company. The Formosa bond is in some respects the equivalent of the Japanese Uridashi bond. In other words, itÆs a product designed for Taiwanese investors to buy a foreign-currency denominated bond. The objective is to provide Taiwanese investors with an instrument offering higher yields than TaiwanÆs own debt markets û where yields are low and prices high, as in many countries around the region.

The question of the future of bond prices was also mooted, given that in the week ahead of the conference, the Taiwanese regulator has abruptly raised short term rates. This caused yields to increase sharply on the back of tumbling bond prices, and was assumed by some investors to be a warning that the Taiwanese central government was not happy with investors using the Taiwan dollar as a carry trade currency. Like the Japanese yen, this occurs when a low-yielding currency is used to invest in a higher yielding currency, such as the Kiwi dollar. The side-effect of such a strategy is that the currency if forced down û exactly as has happened in Japan.

However, not everybody agreed that the Taiwan government had raised rates for that reason, commented FubonÆs Michael Yong.

In terms of securitization, China Development Industrial BankÆs Philip Tsao pointed out that the market was growing rapidly, even if from a very low base. Collateralised bond obligations (CBOs) only started trading in 2005 for example, as did real estate investment trusts (Reits). Still, across all classes the total has grown strongly, with issuance up from $0.79 billion in 2003 to 12.68 billion in 2006.

Philip Tsao also mentioned that securitisation has been given an adequate legal structure in Taiwan through the passing of the 2002 Financial Asset Securitisation Law (FASL) by the Taiwan legislature, which is based on the Japanese model.

He also explained that securitised instruments have the advantage that withholding tax is much lower û just 6% compared to 20% for other investments.

Michael Yong, of Fubon, gave a presentation discussing the past and present characteristics of the bond market, thereby pointing out how much the market has evolved û from a time where interest rates were highly regulated, with limited bond issuance, limited participants and massive illiquidity to a time (currently) where those problems have, in essence, been solved.

Now, private players regularly access the market and the number of participants has soared, comprising banks, securities houses, bills companies and so on. Trading mechanisms have also massively improved, thanks to the establishment of an OTC trading system and standard settlement procedures.

Last, but not least, conference goers were treated to a presentation by BarclayÆs Gilbert Wong on the bank capital market. He pointed out that with the recent passing of the Bank of International Settlements guidelines for the Basel 2 bank regulation, the issuance of new, hybrid capital structures is increasingly important. Wong pointed out that he believed many of these structures could be relevant to the Taiwanese financial institutions.

Overall, the conference succeeded in both introducing the Taiwan market to foreign investors, and conversely, enabling foreign banks to explain how their special skills could be beneficial to Taiwanese entities.
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