Bond market development: The case of Hong Kong

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Bond market development The case of Hong Kong
Alfred Wong Hong Kong Monetary Authority
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Outline

• I. Motivation to develop bond market
• Authorities efforts
• Lessons and impediments

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Part IWhat motivates the authorities to develop
the local currency bond market?
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An overview of the financial system
Financial Markets
Money market Bond market Equity market
Borrowers Households Firms Government
Lenders Households Firms Central bank
Banks and other financial institutions Insurance
companies and pension funds Other financial
intermediaries
Financial Intermediaries
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Financing structure in Asia 1996
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Motivation of the authorities

• Lessons from the Asia financial crisis
• Currency and maturity mismatches
• Prone to sudden capital flow reversal
• To foster financial stability
• As back-up facilities
• Diversity in financial intermediation

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The role of the State

• A multifaceted role
• Investor protection
• Innovation
• Provision of market infrastructure
• Positive non-interventionism
• Facilitating, not forcing!

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Part IIWhat have the authorities done to
develop the local currency bond market?
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Major initiatives taken since the Asian financial
crisis

1. Product development
2. Market infrastructure
3. Tax and regulation
4. Regional cooperation

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1. Product development

• Government issues
• Securitised debts
• Bond funds
• Retail bonds

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Government issues

• Exchange Fund Bills and Notes (EFBNs)
• HK debt instruments issued by the HKMA
• Benchmark yield curve
• Good liquidity in the secondary market
• Banks collectively hold about 85 of the
  outstanding EFBNs for
• favourable risk weighting and
• can be used as collateral to borrow from the HKMA
• Government bonds
• The Government successfully launched its first
  global bond offering in July 2004
• Total HK20 billion of which US1.25 (around 50)
  in a 10-year US denominated bond

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Securitised debts

• The Hong Kong Mortgage Corporation
• Established by the Hong Kong SAR Government in
  March 1997
• To promote development of a secondary mortgage
  market
• mortgage purchase
• debt issuance
• securitisation of mortgage loans
• mortgage insurance
• In May 2004, the Government sold HK6 billion
  (US770 million) of securitisation bonds, backed
  by toll revenues from 5 tunnels and 1 bridge to
  finance infrastructure projects

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Bond funds

• An EMEAP initiative ABF1 (2003)
• Closed-end Confined to investment of the central
  banks only
• USD-denominated sovereign and quasi-sovereign
  bonds in the region
• ABF2 (2005)
• Open to any interested investors
• Domestic currency-denominated bonds in the region

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Retail bonds

• The Hong Kong Mortgage Corporation first offered
  bonds to retail investors in October 2001
• The HKMA operated a pilot scheme to stimulate
  retail investment in Exchange Fund Notes in 2003
• The programme was refined in 2005 under which the
  fee structure was simplified and retail
  distributors were appointed

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2. Market infrastructure

• Benchmark yield curve
• Hong Kong bond settlement system
• On-line access to market information for retail
  investors

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Benchmark yield curve

• A domestic yield curve gradually took shape when
  the HKMA began issuing Exchange Fund papers in
  1990s
• Considerable effort has been directed at
  maintaining a smooth and continuous yield curve
  in designing the EFBN issuance programme

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Hong Kong dollar bond settlement system

• Central Moneymarkets Unit (CMU)
• Established in 1990 to provide computerised
  clearing and settlement facilities to debt
  securities
• Linked with other major international securities
  settlement systems
• To foster cross-border bond trading and investment

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Clearing and settlement system
CDC - China
USD RTGS (2000)
Clearstream
2003
2004
DvP
Euroclear
1994
PvP
2002
PvP
1994
CMU
HKD RTGS(1996)
DvP
1997
AustraClear - Australia
PvP
DvP
1998
1999
AustraClear - New Zealand
KSD - South Korea
EURO RTGS (2003)
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On-line access to bond prices

• CMU Bond Price Bulletin website
• Launched in 2006
• Provides convenient access to indicative bond
  prices quoted by major banks in Hong Kong

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CMU Bond Price Bulletin
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3. Tax and regulation

• Demand side
• tax concessions to bond buyers
• Trading profits from bonds with a maturity period
  of 7 years or more (issued after 5 March 2003)
  were exempted totally from profits tax
  (previously 50 tax concession)
• Minimum maturity requirement for the 50 tax
  concession was relaxed from 5 to 3 years
• Supply side
• simplified issuance process for fund raisers
• The Government and the Securities and Futures
  Commission have together streamlined regulations
  and procedures for issuing and listing debt
  securities
• Enabled issuers to market their offers with
  greater flexibility and effectiveness to the
  public
• Lowered issuance costs

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4. Regional cooperation

• APEC Initiative on the Development of
  Securitisation and Credit Guarantee Markets
• Asian Bond Market Initiative (ABMI)
• Asian Bond Fund (ABF)

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After all these
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Hong Kong dollar bond market

• Steadily growth over the past decade
• Outstanding Hong Kong dollar bond reached US85
  billion at end-2005
• Almost 50 of GDP

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Local currency bond outstanding
US billion
of GDP
Sources HKMA and HK Census and Statistics
Department.
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Market growth by issuer
US, bn
US, bn
Source HKMA.
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Financing structure in 2005
As at end-September 2005
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Part IIILessons and impediments any more we
can do?
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More work to do?

• Macroeconomic policies
• Government bonds
• Banking sector soundness
• Corporate governance
• Regulatory framework
• Tax treatment / incentives
• Investor base

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Impediments to the Hong Kong dollar bond market

• Supply
• Issuance of Exchange Fund papers is limited
• Government issuance is politically sensitive
• Lack of corporate issuers
• Business size
• Credit bureaux
• Demand
• Mutual funds invest mainly in equities
• Currency board system

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Retail demand for bonds

• Transaction cost is high for individuals
• Increased competition between banks made deposits
  fiercely competitive
• Attraction is mainly on medium term papers
• There is more interest in holding bonds via other
  investment vehicles (e.g. mutual funds)
• Any more room for ABF2-typed initiatives?

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Looking ahead

• Market making system
• League table
• Tender arrangements
• Uniform-price auction
• Length of the yield curve
• Number of EFN issues
• EFN futures market
• Electronic trading platform

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Conclusion

• The Hong Kong bond market has grown steadily
  since crisis
• Structure of financing still tilted towards loans
  and equities
• Scope for improvements