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An Overview of Corporate Bond Markets and Policy Issues

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Title: An Overview of Corporate Bond Markets and Policy Issues


1
An Overview of Corporate Bond Markets and
Policy Issues
  • S. Ghon Rhee
  • K. J. Luke Distinguished Professor of Finance
  • Executive Director
  • Asia-Pacific Financial Markets Research Center
  • University of Hawaii
  • Workshop on Developing Corporate Bond Market in
    APEC Economies
  • August 6-8, 2004
  • Shanghai, China
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii

2
Bonds Outstanding in 2002


-

(in US Billion)

Asia-Pacific Financial Markets Research Center,
University of Hawaii
3
East Asian Bond Markets
Outstanding Domestic Bonds (in US Billion)
Asia-Pacific Financial Markets Research Center,
University of Hawaii
4
Financial Sector Profile 2002
Asia-Pacific Financial Markets Research Center,
University of Hawaii
5
Two Major Questions on Bond Market Development
  • 1. Why are bond markets so small in Asia?
  • 2. Why hasn't the secondary market developed in
    economies with large primary market?
  • OECD Workshop on Debt Securities Markets in the
    Dynamic Asian Economies, September 8, 1992 in
    Hong Kong
  • Rhee, 1993, Fixed Income Securities Markets in
  • Six Dynamic Asian Economies
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii

6
Five Underlying Reasons (I)
  • 1. Controlled or administered interest rates
  • Low effective yields without reflecting current
    market conditions
  • Reliance on captive demanders
  • Illiquid secondary market
  • 2. Dominance of banking sector over capital
    markets
  • Heavy reliance of bank short-term loans by
    private corporations
  • Requirement for collateralization or guarantees
    by financial institutions for corporate bond
    issues
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii

7
Five Underlying Reasons (II)
  • 3. Limited supply of long- and short-term fixed
    income securities
  • Statutory restrictions
  • Government regulations
  • Banking sectors resistance
  • Poor credit ratings of issuers
  • 4. Limited Institutional Investor Base Lack of
    Individual Investors Participation
  • 5. Under-developed market infrastructure
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii

8
Six Major Impediments in Developing Bond
Markets
  • 1. Lack of Benchmark Yield Curves
  • 2. Limited Supply of Quality Bond Instruments
  • 3. Captive Nature of the Primary Markets
  • 4. Small Investor Base
  • 5. Fragmented Regulatory Structure
  • 6. Inadequate Market Infrastructure
  • Complacency Prevailed!
  • ADB High-Level Policy Dialogue on East Asian
    Financial Crisis, March 1999
  • Rhee, 2000, Rising to Asias Challenge Enhanced
    Role of Capital Markets

Asia-Pacific Financial Markets Research Center,
University of Hawaii
9
Lack of Benchmark Yield Curves (I)
  • Operational Reasons for Government Bond Issues
  • 1. To Finance Fiscal Deficits
  • 2. To Sterilize Large Capital Inflows
  • 3. To Provide benchmark yield curves
  • Concentration of new issues in limited standard
    maturities enables their use as benchmarks
  • Spreading few benchmark issues across a range of
    maturities leads to a benchmark yield curve

Asia-Pacific Financial Markets Research Center,
University of Hawaii
10
A Recent Success Story of Korea Liquidity
Increase in Benchmark Bond Issues
  • Introduction of the Fungible Issue and Reopening
    Systems
  • Benchmark-designated Bond Issues have identical
    maturities and coupon rates
  • By adopting the reopening system, Korea expanded
    the size of bond issues of the same maturities.

Asia-Pacific Financial Markets Research Center,
University of Hawaii
11
The Effect of the Reopening System in Korea
3.5 times greater
Asia-Pacific Financial Markets Research Center,
University of Hawaii
12
Lack of Benchmark Yield Curves (II) Chinas
Example
  • a. Deposit interest rates are serving as
    benchmark
  • b. MOF sets a range of bidding spreads at the
    primary market auction
  • c. Why very little differences are observed
    between savings bonds and book-entry bond
    yields?
  • Savings Bonds Syndicated Underwriting
  • Book-Entry Bonds
  • Uniform Price Auction Method

Asia-Pacific Financial Markets Research Center,
University of Hawaii
13
Fragmented Regulatory Structure (I)
  • Malaysia in Pre-Crisis Period
  • Bank Negara vs. Securities Commission
  • China at Present Fragmented Regulatory
    Structure of Government Bond Markets
  • a. Dual Supervisory Structure of
    Primary Market
  • T-Bonds and E-Bonds MOF
  • F-Bonds PBOC
  • b. Dual Supervisory Structure of Secondary
    Market
  • Inter-Bank Market PBOC
  • Over-the-Counter (OTC) Market PBOC
  • Exchange Market CSRC

Asia-Pacific Financial Markets Research Center,
University of Hawaii
14
Fragmented Regulatory Structure (II)
  • Consolidated Regulatory Agencies
  • Thailand, Korea, Taiwan, Singapore
  • Indonesia at Present
  • Financial Services Authority (or Otoritas Jasa
    Keuangan, OJK) under plan to replace Capital
    Market Supervisory Agency (BAPEPAM)

Asia-Pacific Financial Markets Research Center,
University of Hawaii
15
Expansion of Investor Base (I)
  • Key Groups of Investors
  • Banks, Insurance Companies, Public and Private
    Pension Funds, Mutual Funds
  • International Investors
  • Individual Investors
  • A diversified and heterogeneous investor base
    promotes liquidity and stabilizes market demand
  • a. Insurance Companies and Pension Funds are
    demanders of long-term, low risk bond
    instruments
  • b. Mutual Funds are demanders of short-term bond
    instruments

Asia-Pacific Financial Markets Research Center,
University of Hawaii
16
Expansion of Investor Base (II)
  • Policy Measures for Developing a Broader-Based
    Market focus on
  • Moving bond instruments out of bank asset
    portfolios
  • Direct access to retail and/or foreign investors
  • Structural reform of pension and retirement funds
  • Reform or creation of mutual funds (especially
    bond funds)
  • Diverse Types of Bond Instruments

Asia-Pacific Financial Markets Research Center,
University of Hawaii
17
Fixed-Income Securities in the US Market (as of
March 2004)
Unit US Billion
  • Municipal Bonds 1,943.3 ( 8.62)
  • Treasury Securities 3,720.9 (16.51)
  • Mortgage-Backed Securities 5,344.0
    (23.72)
  • Corporate Bonds 4,542.7 (20.16)
  • Federal Agency Bonds 2,654.0 (11.78)
  • Money Market 2,588.0 (11.49)
  • Asset-Backed Securities 1,758.5 (7.76)
  • Total 22,531.4 (100.00)
  • includes Commercial Papers, Bankers
    Acceptances, and large Certificates of Deposits

Source US Bond Market Association
Asia-Pacific Financial Markets Research Center,
University of Hawaii
18
Fixed-Income Securities in Thailand (as of
December 2003)
Unit US Billion
  • Municipal Bonds none ( 0.00)
  • Treasury Securities 21.73 (45.87)
  • Mortgage-Backed Securities none (
    0.00)
  • Corporate Bonds 9.43 (19.91)
  • Government Agency Bonds 6.06 (12.79)
  • Money Market n.a. (n.a.)
  • Asset-Backed Securities none ( 0.00)
  • Total 47.37 (100.00)

Asia-Pacific Financial Markets Research Center,
University of Hawaii
19
Fixed-Income Securities in Korea (as of December
2003)
Unit US Billion
  • Municipal Bonds 8.28 ( 1.40)
  • Treasury Securities 121.43 (20.52)
  • Mortgage-Backed Securities n.a. (
    n.a.)
  • Corporate Bonds 168.03 (28.31)
  • Government Agency Bonds 295.43 (49.78)
  • Money Market n.a. (n.a.)
  • Total 593.52 (100.00)
  • 75 of Corporate Bonds are Asset-backed
    securitites
  • Includes Monetary Stabilization Bonds,
    National Housing Bonds, Foreign Exchange
    Stabilization Bonds, Subway Construction Bonds,
    Industrial Financial Debentures, Financial
    Bonds, KAMCO Bonds

Source MOFE, Korea (2004)
Asia-Pacific Financial Markets Research Center,
University of Hawaii
20
Building Bond Market Infrastructure
  • 1. Competitive Auction System among Primary
    Dealers for Government Bond Issuance
  • 2. Hedging Instruments for Interest Rate Risk
  • 3. Credit Rating Culture
  • 4. Clearing and Settlement System
  • 5. Over-the-counter Market Trading System
  • 6. Inter-Dealer Broker System

Asia-Pacific Financial Markets Research Center,
University of Hawaii
21
Issuing Techniques ofGovernment Bonds
  • Fixed Price Public Subscriptions
  • Underwriter consortium utilized
  • Private Placements
  • In the absence of well-functioning secondary
    markets
  • Tap Issues
  • Sold directly into the secondary market through
    branch network of banks or securities companies
  • Auctions
  • Multiple price auction vs. Uniform Price Auction

Asia-Pacific Financial Markets Research Center,
University of Hawaii
22
Multiple- vs. Uniform-Price Auction Method
  • Multiple-price auction method
  • a. Successful bidders pay the prices they bid
  • ... winners curse
  • b. Bidders tend to shade their bids below the
    maximum that they are actually willing to pay
  • Uniform-price auction method
  • a. All successful bidders pay the same price for
    a given security
  • b. Hence, some successful bidders may pay a lower
    price than they actually bid.

Asia-Pacific Financial Markets Research Center,
University of Hawaii
23
Issuing Techniques ofamong OECD Members
  • Uniform Price Auction
  • Finland, Italy, Netherlands, Norway, and
    Switzerland, UK, US
  • Multiple Price Auction
  • Australia, Austria, Canada, Japan, Sweden, UK
  • Tap Issue
  • US, UK, Germany, Canada, and most of OECD
    members, but not Japan

Asia-Pacific Financial Markets Research Center,
University of Hawaii
24
Asia-Pacific Financial Markets Research Center,
University of Hawaii
25
Hedging Instruments for Interest Rate Risk
  • A. Most Asian economies are trading bond futures
    (for long-term interest rate hedging) and
    short-term interest rate futures
  • B. Exceptions
  • China, Indonesia, Philippines, and Thailand
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii

26
Bond Rating Culture Regional Bond Rating
Agencies
  • Number of Domestic Adoption of IAS
    Statements
  • Country Credit Rating Agencies by Stock
    Exchanges
  • Australia Open to Global CRAs Yes
  • China 6 No
  • Hong Kong SAR Open to Global CRAs Yes
  • Indonesia 2 No
  • Japan 3 Open to Global CRAs Yes
  • Korea 4 Yes
  • Malaysia 2 Yes
  • Philippines 1 No
  • Singapore Open to Global CRAs Yes
  • Taipei,China 1 Yes
  • Thailand 2 Yes
  • Viet Nam To be established
    No

Asia-Pacific Financial Markets Research Center,
University of Hawaii
27
Clearing and Settlement
  • Government Bonds Corporate Bonds
  • Australia Reserve Bank Information Financial
    Transactions Recording and
  • and Transfer System Clearance System
  • China Government Securities SDC
  • Depository Trust Clearing Co.
  • (for Inter-bank market)
  • Securities Depository and
  • Clearing Co. Ltd. (SDC)
  • (for Exchange Market)
  • Hong Kong Central MoneyMarkets Unit Central
    Clearing Settlement System
  • Japan BOJ Financial Network Japan Securities
    Depository Center
  • System (BOJ-NET)
  • Japanese Government Bond
  • Clearing Corp.
  • Singapore Government Book-Entry System Debt
    Securities CS System

Asia-Pacific Financial Markets Research Center,
University of Hawaii
28
Bond Trading Systems Order- vs. Quote-Driven
Trading
  • Pre-trading negotiations and personal
    relationships among bond dealers are critically
    important
  • Automated trading system cannot offer these
    relationship
  • Korea Stock Exchanges Experience
  • Thai Bond Dealing Centers Role
  • A bond exchange, an inter-dealer broker, or a
    center for compiling bond price information?

Asia-Pacific Financial Markets Research Center,
University of Hawaii
29
Korea Stock Exchanges Experience
  • Korea Stock Exchange (March 1999) introduced an
    inter-dealer broker system for government bonds
    trading.
  • Trading Volume ( billion) OTC KSE
  • 1999 167 234
  • 2000 170 20
  • Lesson Individual negotiations on OTC market
    cannot be replaced by impersonal auction
    system

Asia-Pacific Financial Markets Research Center,
University of Hawaii
30
Role of Inter-Dealer Brokers
  • Brings market makers together
  • Disseminates trading information to the market
  • Promote secondary market liquidity, depth,
    transparency
  • Earns commission for arranging trades at
    pre-agreed fees
  • Unlike market makers, no positions are taken by
    IDBs
  • Adopted by Most East Asian Economies
  • (Singapore, Hong Kong, Thailand, Korea)

Asia-Pacific Financial Markets Research Center,
University of Hawaii
31
Looking Forward What Do We Need in Asia?
  • Promotion of Asset-Backed Securities
  • Development of Mortgage-Backed Securities
  • Establishment of Credit Guarantee and Enhancement
    Programs for Small- and Medium-Size Enterprises
  • Financial Autonomy for Municipal Government
    Development of Municipal Bond Markets
  • Promotion of Creditor Right and Streamline
    Corporate Bankruptcy Proceedings
  • Legal Framework for Bond Borrowing and Lending to
    Promote REPO Markets

Asia-Pacific Financial Markets Research Center,
University of Hawaii
32
Thank You!For Further References,Please visit
http//www2.hawaii.edu/rheesg
  • Asia-Pacific Financial Markets Research Center,
    University of Hawaii
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